Lifetime Isas may need to carry warnings for some savers
But the Treasury Committee said the dual-purpose design of the Lifetime Isa, or Lisa, may be diverting people away from more suitable products.
MPs found that the objectives to help people save for both the short and long term make it more likely that people will choose unsuitable investment strategies.
Lisas held in cash may suit those saving for a first home, but may not achieve the best outcome for those using accounts as a retirement savings product, as they are unable to invest in higher-risk but potentially higher-return products such as bonds and equities, the committee said.
It also described current rules penalising benefit claimants as 'nonsensical'.
Under the current system, any savings held in a Lisa can affect eligibility for universal credit or housing benefit, despite this not being the case for other personal or workplace pension schemes, the committee said.
The report said: 'The Government provides higher levels of contribution through tax relief to many other pension products that are not included in the universal credit eligibility assessment, such as workplace pensions and Sipps (self-invested personal pensions). Treating one retirement product differently from others in that regard is nonsensical.'
The report added: 'If the Government is unwilling to equalise the treatment of the Lifetime Isa with other Government-subsidised retirement savings products in universal credit assessments, Lifetime Isa products must include warnings that the Lifetime Isa is an inferior product for anyone who might one day be in receipt of universal credit.
'Such warnings would guard against savers being sold products that are not in their best financial interests, which might well constitute mis-selling.'
Savers can put in up to £4,000 into a Lisa each year, until they reach 50. They must make their first payment into their Lisa before the age of 40.
The Government will add a 25% bonus to Lisa savings, up to a maximum of £1,000 per year.
People can withdraw money from their Lisa if they are buying their first home, aged 60 or over or terminally ill with less than 12 months to live.
People withdrawing money from a Lisa for any other reason face a 25% withdrawal charge, and can end up with less money than they put in.
The report said: 'The withdrawal charge of 25% is applied to unauthorised withdrawals, causing Lisa holders to lose the Government bonuses that they have received, plus 6.25% of their own contributions.
'Several witnesses described that loss of 6.25% as a 'withdrawal penalty'.'
There are also restrictions on when Lisas can be used to buy a first home, including that the property must cost £450,000 or less.
The report said: 'Many people have lost a portion of their savings due to a lack of understanding of the withdrawal charge or because of unforeseen changes in their circumstances, such as buying a first home at a price greater than the cap.
'However, the case for reducing the charge must be balanced against the impact on Government spending. The Lifetime Isa must include a deterrent to discourage savers from withdrawing funds from long-term saving.'
It also added: 'Before considering any increase in the house price cap, the Government must analyse whether the Lifetime Isa is the most effective way in which to spend taxpayers' money to support first-time buyers.'
The committee noted that in the 2023-24 financial year, nearly double the number of people made an unauthorised withdrawal (99,650) compared to the number of people who used their Lisa to buy a home (56,900).
This should be considered a possible indication that the product is not working as intended, the committee said.
At the end of the tax year 2023–24, around 1.3 million Lisa accounts were open, the report said.
The Office for Budget Responsibility predicts spending on bonuses paid to account holders will cost the Treasury around £3 billion over the five years to 2029-30 – and the committee questioned whether this product is the best use of public money given the current financial strain.
MPs also raised concerns that the product may not be well enough targeted towards those in need of financial support and could be subsidising the cost of a first home for wealthier people.
It said the data on this issue remains unclear.
The report also highlighted the benefits of certain elements of the Lisa, including being an option for the self-employed to save for retirement.
Treasury Committee chairwoman Dame Meg Hillier said: 'The committee is firmly behind the objectives of the Lifetime Isa, which are to help those who need it onto the property ladder and to help people save for retirement from an early age. The question is whether the Lifetime Isa is the best way to spend billions of pounds over several years to achieve those goals.
'We know that the Government is looking at Isa reform imminently, which means this is the perfect time to assess if this is the best way to help the people who need it.
'We are still awaiting further data that may shed some light on who exactly the product is helping. What we already know, though, is that the Lifetime Isa needs to be reformed before it can genuinely be described as a market-leading savings product for both prospective home buyers and those who want to start saving for their retirement at a young age.'
Brian Byrnes, head of personal finance at Lifetime Isa provider Moneybox said: 'The report marks a further opportunity to engage with policymakers and continue the conversations needed to ensure the Lisa continues to offer the best level of support to those that need it most.'
He added: 'While it is right that the Government ensures the Lisa provides value for money as part of its review of the product, it is our view that it absolutely does…
'The Lisa has proven particularly valuable for first-time buyers on lower to middle incomes, with 80% of Moneybox Lisa savers earning £40,000 or less.'
He continued: 'We firmly believe that by future-proofing the house price cap and amending the withdrawal penalty, the Lisa would continue to serve as a highly effective product, helping young people build and embed positive saving behaviours early in life, get more people onto the property ladder, and prepare for a more secure retirement.'
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