icleID=51506&categoryID=14">Part III
addresses recent reforms to the ISA regime and whether or not they hit the mark; and Part IV discusses the future of ISAs.Economic Secretary Ed Balls has hailed the ISA as a “vital part” of the Government’s efforts to encourage long term saving, and to underline the point, the Treasury has confirmed that the annual ISA allowance will remain in place beyond 2010, the previously contemplated end date. Given that they appear to be here to stay, it’s an appropriate point to look back over the somewhat chequered history of the ISA since its introduction in 1999.
The Introduction of ISAs
When Gordon Brown announced the introduction of the ISA in his first Budget, the proposals went down like the proverbial lead balloon. The scrapping of the much-loved previous tax incentivised savings schemes in favour of something that looked at first sight like a pale and inadequate substitute was roundly condemned not just by investors, but by many commentators, investment companies and financial advisers.
The main bone of contention was that the investment limits on ISA compared unfavourably with the limits that applied previously to Personal Equity Plans or PEPs (for Stock-market investment) and Tax Exempt Special Savings Accounts – TESSAs - (for cash). These vehicles, introduced by successive Tory Chancellors through the 1980s allowed, effectively, tax exempt savings of up to £10800 per year (£9000 per year into PEPs and £9000 spread over 5 years into a TESSA). Therefore, the more modest ISA limit of up to £7000 with £3000 as the Cash element (intended originally to be reduced to £1000 after one year) was seen, far from encouraging savings, as an “attack” on the savings industry – and probably the thin end of the wedge at that!
Allied to this, the rules relating to the new product were seen as complex and abstruse. Investors and advisers alike grappled with the complexities of the “Maxi and Mini” rules, the Cash, Life Assurance (only a dedicated few ever did work this one out!) and Stock-market elements, the different investment limits on each element, when you could invest with different providers in the same year – and when you couldn’t, etc., etc.
To add further fuel to the doubters' fears, a few months previously, the Chancellor had announced the demise of Advanced Corporation Tax. Under Advanced Corporation Tax rules, the managers of pension schemes and other tax-sheltered investments such as PEPs and ISAs had been able to reclaim a tax credit (then 20%) on share dividends; the abolition of the tax also, effectively, abolished the tax reclaim. ISAs enjoyed a limited “stay of execution” in that managers were allowed to reclaim the tax credit at the new rate of 10% but only up to April 2004.
The Initial Success of ISAs
Many predicted that this “double whammy” of complex rules together with less generous contributions and tax-credits would presage a big thumbs-down from the investing public. However, this assessment failed to take account of the overheated market conditions of 1999 and 2000. Stock-market ISAs benefited from the “tech boom” which saw investors ploughing into technology fund ISAs – nobody was worried about complex rules or tax benefits, would-be investors just wanted a piece of the action! Thus, the 12-month period immediately after launch saw net Stock-market ISA sales of £9 billion*.
What’s more, like the PEP and the TESSA before it, strong marketing propelled sales. “Have you got your ISA yet?” became a common marketing message in the shop window of every Bank and Building society and, each year, the days before the tax year end saw a feverish rush as people raced to meet the 5th April deadline.
Stock-market ISAs: The End of the Honeymoon Period
The bursting of the tech bubble in 2000 and subsequent market collapse following 9/11 was a rude awakening to many of these new ISA investors and flows into ISAs have never in subsequent years come close to matching the heady heights of the first year of 1999 / 2000. Over the years after 2000, disillusionment with Stock-market investment in general and ISAs in particular grew as those badly-burned by the technology implosion tended their wounds and opted for Cash ISAs instead. Indeed, even in 2006, well into another bull market, net sales had “recovered” only to a figure just in excess of £2.5 billion* for the year.
Even the Cash ISA suffered to a degree from falling interest rates, which, of course, contributed towards persuading people to “buy now and borrow” rather than “save up for the future”.
ISAs Today: a Qualified Success Story?
Nevertheless, despite the long, winding and rocky road the ISA has travelled since 1999, it is fair to say that those who predicted its failure – and indeed the beginning of the end for tax incentivised saving - have been proven wrong, at least to some degree.
On the one hand, it is hard to argue that an investment where balances at the end of 2006 stood at £220 billion and where 17% of the adult population hold at least one ISA account has been a failure. The Government itself also appears to have grown to love its own creation rather more over the years. The original plan to reduce the annual cash limit to £1000 never came to pass and whispers in darkened corridors about reducing overall limits proved groundless. Now (not before time) the limits are finally going up; from April 2008, the complex rules are being simplified and the ISA’s future is secured beyond 2010 (unless, of course, a future Government deems otherwise).
However, before the Treasury slaps itself too vigorously on the back over the success of the ISA, it is significant to note that only around 25% of the total £220 billion estimated to be invested in ISAs by the end of 2006 was invested in Stock-market ISAs (with much if not all of the balance, of course, being held in the Cash version).
We have no doubt that this can be explained to a great extent by a basic lack of understanding of the nature – and long term benefits - of stock-market investing. In 2006, the FSA sponsored Baseline Survey into financial capability in the UK discovered that, even among those who held a Stock-market ISA, 40% of investors surveyed failed to realise that its value would be affected by the ups and downs of the market. Many investors who lost a packet following the tech collapse were under the wholly mistaken impression that their investment was, underwritten by the Government and that they were therefore somehow protected against stock-market loss.
Therefore, at this stage, it seems that the ISA has been only a qualified success in encouraging good long term savings habits and the much-trumpeted 1980s concept of a “share owning democracy” seems a lifetime ago. The ISA, given its tax incentives, has undoubtedly helped to encourage people to save – although even this claim should be seen in the context of the UK’s current record of over £1 trillion personal debt – but it has not necessarily helped enough people to save wisely and in the most effective manner.
In the next article, we will look to the future, assess the potential impact of the new rules and consider what the Government – and other stakeholders in the investment world such as the FSA and, not least, the industry can do to help improve savings habits.
* IMA Statistics Dec 2006
