A new tax year is upon us — and there’s always one person who wants to tax investors even more.
A couple of days ago, the Resolution Foundation published an interesting take on the current ISA regime, noting that it is:
- Expensive and growing in cost
- Poorly targeted, with vastly more tax relief given to those on higher incomes
- Ineffective at raising long-term savings rates
The organisation has previously campaigned to set a lifetime allowance of £100,000 for ISA saving and continues to maintain this position. I would encourage readers here to also read the piece, linked here, for balanced counterviewpoints.
I think the ISA allowance is perfectly reasonable.
Let’s dive in.
ISA allowance explained
Let’s quickly run through the basics.
An ISA (Individual Savings Account) is a vehicle that offers tax benefits compared to investing within a GIA (general investment account).
Investors can save a total of up to £20,000 per tax year from your net income across multiple ISAs, and returns are free of income tax, capital gains tax or dividend tax.
This differs from a SIPP, where you can invest £60,000 per tax year from your gross income. You are then taxed on withdrawal (excluding a one-time deal). And you can only withdraw past a certain age (rising to 57, but likely higher by the time anyone under 50 gets there).
There are multiple ISA types:
- Cash ISA — including instant access, regular savings, and fixed rates. These are usually deemed low risk but can offer an interest rate lower than inflation AND almost always underperform a diversified stocks and shares ISA over time.
- Stocks and Shares ISA — allows you to invest shares, bonds, and funds free of capital gains or dividend tax. Returns are not guaranteed, and you can lose some or all of your initial deposit. This is unlikely in a diversified portfolio over the long term, but can happen.
- Lifetime ISA (LISA) — you can save up to £4,000 per year in a LISA, which is then topped up by 25% by the government, up to £1,000 per year until you turn 50. If you invest the full £4,000 allowance, this leaves you with £16,000 to invest in other ISA accounts. The money must be used to buy your first home, or it can be withdrawn at the age of 60. You must be over 18 and under 40 to open a LISA. You can invest in cash or shares as usual. Early withdrawals come with a penalty charge.
- Innovative Finance ISA — beyond most pay grades, typically very high risk, high reward and often offering products without FSCS protection.
There are a few further important points to consider:
- The Lifetime ISA is restrictive, but the 25% guaranteed bonus is unbeatable.
- The power of compounding returns is hugely amplified in an ISA, as no tax on compounded returns is enormously powerful.
- Unlike a SIPP, your ISA allowance functions on a use-it-or-lose-it basis. Your allowance resets with the beginning of the new tax year.
Resolution’s viewpoint
Resolution notes that 22 million adults benefitted from an ISA in 2021-22, with the associated tax relief to ‘cost the Treasury £6.7 billion in 2023-24, up from £4.9 billion in 2022-23.’ And they argue that ‘vastly more tax-relief is given to those on higher incomes as they are more likely to have an ISA and more likely to have substantial ISA savings.’
‘In 2018-20, 1-in-2 (54 per cent) working-age families in the top 10 per cent of the income distribution had an ISA, compared to less than 1-in-5 (18 per cent) in the bottom 10 per cent.’
And they are also apparently ineffective at raising long-term saving, as ‘when the ISA allowance was increased between 2013-14 and 2014-15 this had no noticeable impact on aggregate household saving.’
They also note that the new British ISA will only benefit the 7% (1.6 million people) of ISA holders who max out their current allowance — I also think the policy should be scrapped, not least because it is a pointless gimmick.
Resolution argues that with one in three working-age adults with savings of less than £1,000, ISAs are simply poorly targeted. In addition to capping ISA investments to £100,000, the foundation wants some of the additional revenue that would theoretically be raised to be spent expanding the ‘Help to Save’ policy which allows low-income families to get a bonus of £25 per month for four years if they save the max of £50 per month.
They also mention behavioural framing — such as pensions autoenrollment — as better than financial incentives, and that these should be the priority for any government.
Again, read the article.
My view
While the cost of ISA tax relief might well rise to £6.7 billion, this is largely due to higher interest rates boosting savings rates. Indeed, most ISAs are still cash ISAs — the argument seems to be that because ISAs are popular and rates finally back to a reasonable level, investors should have their lower risk returns reduced.
The government has already decreased the dividend allowance to a pitiful £1,000. And increased dividend tax. And reduced the capital gains tax-free allowance from £12,300 to just £3,000. And reduced BADR from £10 million to £1 million. Most HNW investors filling their ISAs also hold more investments outside of them, and these investors have already been hit by allowance decreases and tax increases.
There is a reason why the average person prefers an ISA to a SIPP. It’s easy to understand, and trusted. Reducing the annual allowance, or introducing a lifetime allowance, or a British ISA — they all have the same effect; introducing the same uncertainty that pensions now suffer from.
The idea that you can get more tax out of ISA investors, and then use this cash to boost the Help to Save policy is ludicrous because the Help to Save policy is itself ridiculous. People surviving on benefits do not have £50 a month spare to save. Many do not have enough money to pay the bills and also eat.
The reason why one in three working age adults have less than £1,000 in savings is not because people do not want to save, but because wages are abysmally low in the UK. For perspective, let’s say you earn £35,000 a year, working a professional job in this country.
A 16-year-old McDonalds worker in California now outearns you.
Behavioural framing — such as pensions autoenrollment — may be better than financial incentives and should be the priority for any government. This makes sense, until you realise that people with the lowest incomes are not saving for pensions at all. They can’t afford to. They can’t afford the payslip damage.
In terms of not encouraging saving, this is demonstrably wrong. When FTSE AIM shares were allowed within ISAs in August 2013, there was a massive surge in trading. On 5 August 2013, £123.3 million was traded, up by £50 million. The average daily trading value in 2013 was £156.5 million, rising to £223.5 million in 2014. And the FTSE AIM index surged to boot.
It’s also worth noting that the £20,000 allowance has been the same since the 2017-18 tax year — a real terms freeze — and had this risen with inflation, the allowance would have been upped to nearly £26,000. Interestingly, the British ISA addition would just about match inflation.
There is also the Junior ISA to consider. The £9,000 a year tax free allowance for each child of the wealthiest must also then also be redundant, but the foundation is silent on this. And why not go after the Lifetime ISA? Surely someone who can save £4,000 per year in excess income does not deserve a £1,000 bonus of taxpayer money to go towards a home?
But the bottom line is this: you cannot encourage people who already don’t have enough money to live on, to invest with money that they don’t have.
ISAs for social mobility
You know who can invest? High earners.
High earners in this country — and by this, I mean individuals with high incomes from working, but without substantial wealth as yet — are currently punished by the tax system to the point where upwards social mobility is simply not possible.
A key component of modern capitalism is meant to be that poorer people can, through hard work, become wealthy. But ever rising taxes and frozen tax bands are making this harder every year.
Any employee earning enough to fill their ISA with £20,000 will be using money that has been through the wringer of income tax at 40%, National Insurance at 2%, and student loans at 9% — half of their earnings above £50,000 is already gone to tax.
Add in the High Income Child Benefit Charge, postgraduate loans, or childcare withdrawal and it gets much higher than >50%.
Yes, vastly more ISA tax relief is given to those on higher incomes — but I struggle to see why this is a problem when higher earners have already paid an effective marginal rate of more than 50% on income being put into their ISA. And much of this cash will either be invested into UK companies, or into US companies, with profits eventually spent in the UK.
The reality is that higher earners suffer extremely high taxes, while already wealthy individuals get preferential tax rates. This piece isn’t about the fairness of this, but about considering the attractiveness of the UK as a place to work. When half your income is already taken by the government — don’t get me started on business taxation — and you decide to invest some of what you are left with, it is fair for a portion of this to be tax free.
Higher earners already pay for everything. ONS data for 2020/21 puts 36 million people or 54.2% of the population as paying less tax than the cost of what they receive from the system. And most high earners are internationally nimble. You can emigrate to Portugal or the UAE right now and pay much lower taxes as a digital nomad.
Then there’s the effect on London’s stock market, which is not in a particularly rosy health. Is cutting the ISA allowance going to be good for domestic markets?
The ISA is the carrot for higher earners, many of whom are already on the verge of leaving the UK. It’s unique. There is nothing quite like it anywhere else in the world. And it’s a tax advantage offered, with no restrictions, which goes some way to compensating for high tax rates.
Of course, all being equal, SIPP investing is far more tax efficient as you invest from gross income before tax. For higher earners, this means you can invest double what you could put in the equivalent ISA.
But the government can change the rules for SIPPs at any time. Increase the withdrawal age, reduce the tax-free withdrawal, up the tax rates? A country low on cash may feel like plundering pensions again, and SIPP investors cannot do anything about it as cashing out early is so punitive.
But with an ISA, you can sell up, withdraw the cash, and leave the country whenever you want. And if the Resolution Foundation gets its way, more UK high earners will be convinced to seek the nearest airport.
This article has been prepared for information purposes only by Charles Archer. It does not constitute advice, and no party accepts any liability for either accuracy or for investing decisions made using the information provided.
Further, it is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.
