How to make Isas even nicer

Chancellor Jeremy Hunt wants to broaden the appeal of individual savings accounts (Isas) and inspire more people to invest in the stock market.

Ahead of the Autumn Statement on November 22, the big question is: how might he do this?

These valuable tax-free vehicles have made millions of investors richer since their launch in 1999. But the Financial Times recently reported that Hunt is considering a shake-up of savings and investment accounts to remove barriers to investing, simplify “a complex landscape” of products and potentially offer further incentives for investing in UK-listed equities.

The Treasury is in discussions with finance industry groups about how to do this, saying it was “receptive to ideas of how we can make Isas more attractive to encourage people to develop a savings habit”.

But with limited headroom for tax cuts, finding crowd-pleasing measures that don’t cost the earth will be hard. Industry commentators are not short of suggestions, and neither are FT readers, judging by more than 800 comments on our online story.

From boosting tax allowances to tidying up product ranges and permitting a wider range of investments to be held in Isa wrappers, some of these ideas could expand the appeal of Isas, but others risk adding further confusion to the tax-free investment system that has revolutionised saving for millions since its launch in 1999.

Here are five areas that the chancellor could consider.

The cash conundrum

By far the most popular type of account, cash Isas have attracted an average £44bn of inflows each year since the global financial crisis — nearly double the average £23bn paid into stocks and shares Isas, according to HM Revenue & Customs.

However, investors have enjoyed far superior returns than savers. By value, investment Isas now account for the lion’s share (62 per cent) of the total £741bn held inside these tax wrappers.

Many of the estimated 4.2mn Britons who have more than £10,000 in cash available for investment may regret not taking advantage of stocks and shares Isas — but that’s assuming they realise the benefits. Two-thirds of Britons are unaware, according to polling commissioned by investment broker AJ Bell. Despite the 18-year lock-up, even Junior Isas are also more likely to be held in cash.

Convincing cash hoarders that the stock market is a better long-term home for their money is one of the key issues the chancellor and the Financial Conduct Authority wish to address. But their timing couldn’t be worse.

“The problem is, cash is so much more competitive than it has been,” says Bill Dinning, chief investment officer at Waverton Investment Management.

If savers are prepared to lock their money up for one year, the top cash Isa providers offer a risk-free return of 5.8 per cent or more (Shawbrook and Charter Savings Bank are top, with Close Brothers and Santander not far behind — all accept transfers in).

Shielding higher-rate taxpayers from the penalty of tax on savings interest, cash Isas are now attractive for investors taking a more defensive position, especially if adverse movements in UK gilts and equities have dented portfolio values.

Influential industry voices believe making it possible to save and invest within a single Isa account would make it easier for cash savers to get used to the idea of investing without having to open a separate product.

Andy Bell, founder of investment platform AJ Bell, has spearheaded the “One Isa” campaign, which would end this distinction — a move benefiting investment platforms that already offer a variety of investment services, including cash options (often at derisory rates).

Other pundits make a case for opening up the market by forcing banks and building societies to offer investment options within cash Isas.

“Bigger banks could facilitate this quite easily, whereas smaller providers like building societies could team up with the likes of L&G or BlackRock to offer a simple range of trackers,” suggests Jason Hollands, managing director at wealth manager Evelyn Partners, arguing this would make investment options more visible.

He notes how more than 250,000 customers of Monzo, the digital bank, have joined a waiting list to use a BlackRock-powered investment Isa offering when it launches in coming weeks. Digital natives clearly like the idea of investing via their bank.

Another popular suggestion from FT readers? Rebranding Isas as “tax-free accounts” to make the benefits more obvious to everyone.

More equities please, we’re British

Boosting growth by channelling more investment into UK companies was the key theme of the chancellor’s July Mansion House speech, but the idea of creating an additional Isa allowance for UK equities has divided FT readers.

“I’d rather pay 20 per cent capital gains tax on an S&P 500 or MSCI Global return than have a tax-free nothing much FTSE 100 return,” said one reader, summing up the views of many. Others questioned what would be counted as a UK investment, noting the high overseas earnings of many London-listed stocks.

Theoretically, a Budget day announcement offering an extra £5,000 for UK equities on top of the existing £20,000 annual cap on Isas (as some fund managers have suggested) could drum up some much-needed patriotic fervour for the UK equities market.

Over the past 10 years, the 1.5 per cent the FTSE 100 has returned annually on average has been dwarfed by the 9.7 per return an investor in the S&P 500 has enjoyed.

UK chipmaker Arm choosing to IPO in New York over London this month was a bitter blow for a government pushing a growth agenda, and the weak pound means there’s an ever-present threat of foreign takeovers.

But would a tax break really convince significant numbers of retail investors to allocate more capital to UK stocks and, even if it did, would this be a wise move?

One FT reader dubbed the plans “The Hunt Isa” suggesting this stood for Horribly Undiversified (No Tax). They have a point — home bias is a big issue for British investors.

Hargreaves Lansdown, the UK’s biggest investment platform, estimates £147.5bn is already invested into UK shares, bonds and collective investments through stocks and shares Isas.

This suggests Isa investors have a 37 per cent weighting towards the UK, based on HMRC’s most recent detailed breakdown of the value of stocks and shares Isas from 2020-21.

However, Dinning notes the UK makes up less than 4 per cent by value of the world stock market index. “The combined market cap of Microsoft and Apple is bigger than the UK market as a whole,” he says.

Home bias is even more prevalent among UK investors who buy individual shares as opposed to funds. In the past year, 80 per cent of shares traded on HL’s platform were UK equities.

HL’s view is that boosting levels of UK investment could be achieved simply by raising the overall Isa allowance — which has been stuck at £20,000 since 2017 — instead of overcomplicating things.

From a technical point of view, most investment platform executives agree that the challenges of administering an extra UK-only allowance would undermine making Isas simpler.

Even FT readers who considered UK equities to be dirt cheap on a historic basis recognised they would have to stay invested for the long haul to see any benefits — it’s not the quick fix the chancellor will be seeking ahead of a general election.

And while it sounds like a populist measure, Hollands notes that an additional UK-only allowance would only be relevant to the richest who can afford to pay in more than £20,000 a year. The most recent statistics show that fewer than 15 per cent of Isa subscribers manage this.

“A logical move then for these investors would be to reduce allocations to UK equities within their main allowance,” he reasons. “Would such a measure really drive higher flows into UK-listed shares or just prompt people to reorganise the way they asset allocate across accounts?”

Other taxing Isa issues

Considering recent cuts to capital gains tax allowances and increases to the dividend tax, many FT readers believe an increase to the £20,000 annual Isa limit is long overdue (had it increased with inflation, Hollands calculates it would now be over £25,600).

Plenty of others suggested the chancellor could instead get rid of stamp duty reserve tax on UK shares, charged at 0.5 per cent. “This would persuade me to buy more shares in British companies within my Isa,” said one reader, noting that no stamp duty applies to ETFs, unit trusts or US shares.

But this would also be costly: HMRC figures show stamp duty on shares brought in £3.8bn in the last tax year.

While FT readers greatly appreciate the tax-saving benefits of Isa investing, they know that unlike pensions, the funds inside will eventually be subject to inheritance tax (IHT).

However, holding qualifying Aim stocks within your Isa for more than two years is a very popular — if volatile — IHT workaround.

Could the chancellor be tempted to consider extending a similar IHT exemption to all UK-listed shares?

This would immediately boost the attractiveness of UK stocks, and while it would be expensive, it wouldn’t cost as much as scrapping IHT altogether (as reports have this week suggested the Tories are considering).

Either move would have damaging unintended consequences for Aim investors.

Tidying up Isas

Talk of simplification has prompted calls to reduce the growing number of Isa products (the majority of which are Budget day baubles from previous chancellors).

Many commentators believe the end is nigh for the Innovative Finance Isa. Widely regarded as a flop, this anomaly was introduced by George Osborne to boost peer-to-peer lending, attracting just £144mn of inflows in 2021-22.

By the end of the decade, the Help to Buy Isa will have been phased out, replaced by the hybrid Lifetime Isa (Lisa). This offers a generous 25 per cent government bonus to under-40s saving or investing up to £4,000 a year towards their first property, or to access the money from age 60 to fund retirement. Its complexity has been heavily criticised though.

Plenty of Lisa investors have fallen foul of the £450,000 property price cap, which has not risen in line with house price inflation, or have incurred penalties for accessing their savings. Yet as a rare bit of help for first-time buyers, the government risks alienating younger voters if it too is scrapped.

£75,000Average Isa value for holders with £150,000-plus income

Instead, Hargreaves Lansdown has lobbied the Treasury to repurpose the Lisa and extend the benefits to older investors.

“We think the Lisa is the perfect product for the self-employed if you tweak the rules,” says Nathan Long, senior policy analyst at HL. Noting the low numbers of self-employed people who save into a pension, he believes if the age limit was raised from 40 to 55, millions of gig workers could use Lisas to invest for the long term.

While withdrawals before the age of 60 would lose the government bonus, HL has urged the chancellor to scrap the additional 6.25 per cent penalty: “Removing this would give the self-employed confidence to save for the future, knowing that they could get at the cash in an emergency.”

Isa transfers are another problem area the FT has reported on. Clunky, paper-based processes make it difficult to switch providers — something any refresh should urgently address.

Expanding the remit of Isas

Finally, no shake-up of the Isa regime would be complete without considering what other permissible investments might be allowed inside a tax-free structure.

The most pressing of these is fractional share trading. Many young investors have started their Isa journey using investment apps to buy fractions of popular US shares from as little as £1. When you consider that a single share in Apple now costs $172 (£141) and Amazon $126 (£103) it’s easy to see how fractionals enable stock pickers with less money to build a more diversified portfolio.

Trading apps are currently engaged in a stand-off with HMRC, which claims fractional shares cannot be held in Isas. Updating these rules would be a victory for common sense.

At the same time, the Treasury could consider expanding access to longer-term UK focused investments, in response to industry lobbying.

Currently, Isa rules stipulate that an investor holding a stocks and shares Isa must be able to transfer within 30 days, so illiquid investments which could take longer to sell cannot be held.

£22,000Average Isa value for holders with £20,000-£29,000 income

Tweaking the rules to allow long-term asset funds (LTAFs) to be held within Isas could enable retail investors to gain exposure to assets such as infrastructure projects, commercial real estate and venture capital.

This could appeal to Isa investors with a long-term perspective who are prepared to take more risk. So too could providing follow-on funding to unquoted UK companies seeking capital for their next phase of growth — an idea promoted by VCT and EIS providers.

For nearly 25 years, tax-free investing and savings accounts have been a boon for the British, offering a growing range of flexible investment opportunities to people of all ages.

As Isas enter their next phase of evolution, simplicity, flexibility and digital functionality should be the watchwords, whichever route this chancellor — or the next — decides to take.

Claer Barrett is the FT’s consumer editor and the author of ‘What They Don’t Teach You About Money’. claer.barrett@ft.com Instagram @Claerb