In the March Budget, the government announced a new type of ISA would be launched in April 2017 to help young people buy their first home and save for retirement at the same time.

See YourMoney.com’s All you need to know about the Lifetime ISA guide for the full details of the scheme.

But draft legislation for the Lifetime ISA (LISA) has confirmed that penalty free withdrawals can only be made to buy a first home worth up to £450,000, if the saver becomes terminally ill or after they reach the age of 60.

The government also proposed that the exit penalty will be applied as a 25% charge on the amount of the withdrawal.

Essentially this means the government would receive the bonus it contributed to the LISA, including any interest or growth on that bonus, with an additional charge on top.

Investment platform AJ Bell said the proposed exit charge is “overly punitive” and “should be amended” before the product launches next year.

It said the charge structure would mean the government contributes 20% of the initial investment but then would charge an exit fee of 25% on the entire fund including all investment growth.

So, if someone contributes the maximum £4,000 over 10 years they would have invested £40,000 and this would have been topped up with £10,000 of government contributions to give a total investment of £50,000.

If this grows at 4% per annum after charges, the fund would be worth £62,432.

A 25% exit charge on £62,432 would be £15,608, returning the government’s original contribution of £10,000 plus £5,608. This equates to 45% of all investment growth generated over the period, leaving the investor with £46,824.

‘25% charge has a disproportionate impact on the end value’

Tom Selby, senior analyst at AJ Bell, said: “It is good news that the draft legislation indicates the LISA has been kept simple, with no mention of allowing borrowing or additional withdrawal options. However, it is disappointing to see the government pushing ahead with an exit fee that looks overly punitive if people unexpectedly need access to their savings.

“It is understandable the government would look to recoup its own contribution if a customer decides to withdraw their money early but the 25% level it has set looks too high when you consider the impact it would have on someone’s savings. Although the government bonus has been positioned as 25%, it only equates to 20% of the investment being made.  A 25% exit charge on the whole fund, including investment growth, therefore has a disproportionate impact on the end value an investor would be left with.”

AJ Bell added that it would like the government to reconsider the level of the early exit penalty before the product is launched in April 2017 and to ensure it is set at a level that enables the government bonus to be recouped, plus investment growth on that bonus, but does not eat into the investment growth achieved on the individual investor’s personal contribution.

“If it doesn’t, investors will have to be very sure that they will not need access to their savings for reasons other than a house purchase before locking funds into a Lifetime ISA,” Selby added.