Could Lifetime ISAs seriously damage your wealth?

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In April 2017, the government plans to make new Lifetime Individual Savings Accounts (LISAs) available to anyone between the ages of 18 and 40.

25% extra free

If you open one of these accounts, the great kicker is that any savings you put in before your 50th birthday will be topped up with a further 25% bonus from the government. Wow. I wish they'd been around when I was young enough to qualify.

There will be no maximum monthly contribution and you can plan to save as little or as much as you want each month, up to £4,000 a year. However, with that 25% bonus, it makes sense to save as much as you can so that your invested money works hard for you.

If you understand the laws of compounding -- where you can earn interest on the interest as well as on the initial capital invested -- you're well on the way to building your fortune, if you remain a saver and investor. If you're a borrower, on the other hand, compounding works against you, pulling you away from building your first fortune.

Here are the strings

As we might expect, the proposed Lifetime ISA comes with a few strings. In order to collect the bonus the government gives you your LISA savings must be spent on particular things, otherwise the government will snatch the bonus away AND potentially some of your own savings.

You can spend the money you've saved and the bonus if you use it for a deposit on your first home if it's worth no more than £450,000. You can also use the money you've saved and the bonus for retirement and draw it all out tax-free after your 60th birthday.

If you withdraw the money from the LISA before you're 60 and don't spend it on a house deposit, you will lose the government bonus and any interest earned on the bonus money. On top of that, the government will impose a 5% charge on the rest of your funds, which is how you could end up damaging your wealth with a Lifetime ISA.

Wealth warning

The Financial Conduct Authority (FCA) seems to be concerned that investors may not understand the difference between a pension and a LISA, which is a fair point. If you're tempted to put money in a LISA before putting it in your employer's pension fund, for example, you could miss out on extra contributions that your employer normally makes to your pension.

The FCA wants a wealth warning attached to LISAs to make sure investors understand how they work. For example, to make the further points that savers need to switch to something else after the age of 50; that if you're not buying a home, access to saved money is unavailable until the age of 60 if you want to keep the bonus; and that higher rate taxpayers may be better off with a pension because of tax relief.

Overall, I think it's worth spending time getting to grips with LISAs and planning the opportunity into your overall investment strategy for home ownership and retirement.

After all, it's not every day you get an instant 25% return from which further compounding can help grow your savings.

Other ways to grow your wealth

If you're serious about growing your wealth I'm sure you will look into the opportunity with LISAs. A chance to kick-start the compounding process like that seems too good to miss.

To help you on your quest to build life-changing wealth, the Motley Fool has produced 10 Steps To Making A Million On The Market, a report with practical steps that could help propel you forward.

The report is free to download right now. Click here.

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