ISA tax breaks for savings: cap them at £15,000
The combination of being in government and of facing a large deficit means the list of tax increases and spending cuts Liberal Democrats have been calling for over many years has been mostly exhausted. Capital gains tax is up, pension tax breaks for the richest has been curbed, the ID cards database is gone and so on.
It is good that so many policies are now in place and there are plenty of political battles still to come in the second half of this Parliament, especially over mansion tax. However, it means that the scope for the party to say ‘here is how we would do things differently’ or even ‘here is how we would find the funds for our priority projects’ will be increasingly limited unless the party does come up with new policies that free up money.
So here is one suggestion, that would raise around £1bn per year: put a £15,000 limit on the total amount people can hold tax-free in ISAs (Individual Savings Accounts).
There are two problems with the current tax breaks for ISAs. First, by having an annual ‘use it or lose it’ allowance, the ISA tax breaks disproportionately benefit those who can afford to put in the full tax-free amount every year. If you are very well off you can shelter £11,280 from tax this year, and then the same again (or more, as the allowance is usually increased each year) next and then the year after and so on for ever.
In other words, if you can afford it, you can build up huge levels of tax-exempt saving. What’s more, if you take some of the funds out at any point because you need them, you then lose that part of your allowance. That makes the rules doubly beneficial for the most well-off who can cope with the events life throw up without having to call on their ISA savings.
With pensions there is a lifetime limit on how much you can put into a pension scheme and still receive tax relief; there is no such limit for ISAs. Instead, with ISAs we have a tax system that ends up benefiting more and more the most well off.
The second problem with ISAs is an economic one. The predecessor to ISAs, TESSAs, was introduced by John Major because at a time of economic over-heating he wanted to get people to switch from consumer spending to saving, providing a tax break to encourage this. However, the economy is now in a very different situation.
There is a problem of low long-term pensions savings, but the introduction of the new auto-enrollment pension schemes is the answer to that. There is a problem too of high consumer and housing debt, but paying off that debt rather than saving into ISAs is the better route for people to take. There is also a problem of consumer spending being too sluggish during the current choppy economic recovery, which is what makes the generous ISA allowances currently so ill-suited to our needs.
The solution? Introduce a £15,000 limit of the total ISA holdings people can have. That is a generous enough number not to get in the way of the sorts of levels of savings that most people can look to put away, and means people can benefit from ISAs for short-term saving needs. But for richer people it would encourage them to spend rather than save, which is what the economy needs. For both groups, limiting ISAs does not make pension saving less attractive nor does it hinder paying off existing debts. It would also be a much fairer solution than the current rules, which give more to those who already have the most.
The Social Market Foundation estimates that it would save the government around £1bn a year, money which can then be put to better use. It is a simple and sensible policy we should adopt.
No, unusually for you Mark this is an astonishly daft idea. A lot of very ordinary families are using ISAs *as the Government has specifically encoraged them to over the last 2 decades* as a substitute form of pension saving (our own Coalition government just increased the ISA limit this month, perhaps you didn't notice?)
The limit you've suggested can hit any family with over £15,000 in ISAs, which as you'll appreciate is not actually very much at all if families are using it as a form of pension (most people's pension pots are vastly bigger than this). That's way, way less than a typical family has in equity in housing, and would reach right through the rich into the bottom of the middle clases an even into the working classes.
But worse than that, this change would RETROSPECTIVELY hit everything that had already been invested over many years in ISAs – unlike the proposed changes to higher-rate pension relief (which are a good idea) which would only hit NEW contributions. It would also make no distinction between a family that has sensibly put just £2k into an ISA over many years and invested it very well in stocks that have grown in value; and someone rich in cash who has maxed the limit for 2 years. For people who have invested over many years in areas that have seen a lot of growth this could wipe up to 1/3 of their pension pot away in capital gains tax. ISA investors would see this as a massive betrayal because they could have easily invested in a second pension instead and avoided this new tax…if they hadn't previously listened to their Government's own saving advice.
If you want to cut the ISA bill (and I suggest that isn't a sensible thing to do at all) then the way to do it is to lower the annual saving limit to, say, £2k.
Mark Wright Retrospective issues can certainly be tricky, but this change wouldn't take away the tax breaks people have already received. It would only affect what tax break they receive in future.
For the pensions example you give, someone could move their ISA money to a pension if they wished and if there was a period of advanced notice (certainly required).
They wouldn't lose what they've got in the past and they would then continue to get a tax break (but in this case one that is aimed at a good end – long term saving – and in a good way – with limits on how much the very richest receive). If people switch that way, that seems to me a fine outcome.
You seem therefore to assume that if the rules change people wouldn't be able to move money instead into a pension pot. Not sure why you think that?
Mark Pack – Where in your post does it say that people will be given advance notice of this implementation and the chance to move their finances accordingly? Budgets are often implemented specifically to prevent that, otherwise there's nothing to prevent ISA holders just selling their entire ISA before the date.
But there is a more serious principle here. It's one thing if there's an area of finance that's undertaxed, people pile into it, and the govt moves to regularise the tax regime there. It's altogether another thing if the govt itself creates a low-tax vehicle, says to citizens "Here's a low tax vehicle – Use it!", waits for people to move into it and then slaps a massive tax on the vehicle it was recomending ten minutes ago. There's a name for deliberately enticing people into something and then catching them: it's called "entrapment". A move like this could be very damaging to citizen confidence in Govt initiatives. Who's to say that the next Govt recomendation wont be turned into a trap at a later date?
Seriously, if the size of the national ISA pot is bothering you then you need to shrink down future ISAs by dropping the limit dramatically, not by clobbering all the people who recently followed Govt advice.
I'm not sure about this – the ISA limit also applies to investments in equities and corporate bonds, additional financing for business which may be useful in these times. Perhaps have different kinds of ISAs for different kinds of investment?
Adam Bell Interesting point. I'd query if the broadbrush ISA allowance is the way to achieve that, though, if that's your objective. A tax break which covers savings in all sorts of other areas too doesn't seem the most targeted approach (even assuming that we should be using tax breaks to encourage the sort of investments you mention)?
Mark Pack It does act as an incentive for riskier – and more economically useful – investments, however, and makes them more accessible to people on lower incomes. Someone saving £1,000 per year is much less likely to buy shares if they're going to be taxed on income accruing from them, with the additional paperwork that implies.A broadbrush approach has the advantage of simplicity, which is an incentive in itself.
Adam Bell For someone on lower income, is putting more than £15k in riskier investments something the tax system should encourage? I think the "more than" is key to the answer 🙂
Mark Pack But they wouldnt have to put more than £15k in would they – the value of their holding just need to increase to more than that to be hit. Over a large number of years even £5k could easily grow to more than £15k. PS One man's riskier is another man's obviously sensible. E.g. investing in renewable tech is still "risky", and in the 1990's investing in China was "risky".
Mark Wright I was working on the basis of a £15k cap being a limit on contributions to an ISA, just as the current annual limits are limits on contributions rather than value. You're right that it shouldn't be a cap on value, as that produces all sorts of other problems – including a perverse incentive to having your saving not do too well!
An idea with some sense. But I think any limit would need to be higher. £15k isn't even the deposit on a house today.
As well as the encouragement to save point, some of the issue must be keeping people out of the complexities of CGT.
The practicalities of any limit would need careful exploration. A limit on contributions in, or contributions in net if withdrawals might make more sense than a limit on the actual value, as the last could be triggered by capital gains alone.
I'm at a talk tonight on "rethinking the state's role in enabling individuals to save" (at ILC-UK). I wonder if this report comes up.
BTW, the real predecessor to ISAs were PEPs – TESSAs were cash accounts, not stock-market linked
Martin Lunnon ISAs can be cash accounts too, but fair point – it's both PEPs and TESSAs that are the predecessors.
Don't even consider doing it. Many people are reliant on their ISA for theire pensions and pensioners vote!
Bill – interesting question about what counts as "many". Around half of people have less than £1,000 in savings in total, let alone in ISAs. The proportion of people who have over £15,000 in ISAs in small, and they're not "ordinary" people but rich compared to the rest of the population. They certainly should be treated fairly, but so too should everyone else. Should the huge number of people who have savings far less than £15,000 be paying for the richest to get tax breaks for saving beyond £15,000?