Financial experts and survey data show that the ISA, which is celebrating its tenth Birthday this month, remains a path to financial stability that too few Britons use or understand.
A recent study by Nationwide found that 62% of Britons, who could have an ISA, don’t currently have one.
“Clearly that is somewhat disappointing given the attractiveness of ISA products and the tax-free allowance that comes with these products,” said Lee Raybould, head of savings at Nationwide Building society, when asked about the statistic.
Out of the savings habit
However, Mr. Raybould added: “There are huge numbers of people in the UK who are simply not saving at all let alone saving within an ISA.”
In fact, 23% of Britons do not currently save anything, according to the building society.
This is a course of action that is frowned upon by the savings community.
“We’re now in a world obviously of much more uncertainty and instability and, in a way, it’s even more important as a result to have that nest egg, a fallback plan,” says Hetal Parmar, Manager for of Savings at Alliance and Leicester.
The consequences are dire:
- Nearly 36 million Britons (70%) are still failing to make full use of their tax-free ISA allowance, even though the ISA was introduced ten years ago.
- British savers are unnecessarily handing over 100 million pounds worth of interest to the taxman, added Nationwide.
Use it or lose it
“It’s vital for taxpayers to understand the benefits of saving in a Cash ISA and how to make the most of their allowance,” said Mr Parmar.
“The key thing to remember there is if the allowance isn’t used, it’s lost forever; you will never get that back,” he added.
Many have chosen, despite the sour economy, to lose their allowance rather than use it.
Knowledge gap
Some of it is because of the limited availability of funds to save, however some have lost faith in the savings system, and some of it is due to a lack of knowledge. In one poll, one in six young Britons thought an ISA was an iPod accessory and one in ten thought it was a type of energy drink.
Tim Hague, director of savings and investments at Birmingham Midshires, said: “We have identified that a knowledge gap does exist for ISAs.”
A look at the evolution of tax-free savings accounts in the UK and reveals why this “”knowledge gap”" exists.
Evolution of tax-free savings
In the 1990 budget, which some labelled as “a budget for savers”, the then Chancellor of the Exchequer, John Major, introduced a new tax-free savings scheme, the Tessa – the ISA’s predecessor. However, the tax-free allowances were low and complicated and the accounts were not particularly flexible, even by today’s standards.
ISAs were first introduced in April 1999, and were intended to make tax-free savings simpler and more flexible than they were with the Tessa.
Today
Today, you can invest a total of 7,200 pounds in an ISA per tax year (April 6 to the following April 5) of which up to 3,600 pounds of this limit can be saved in a Cash ISA. The remaining allowance can be invested in a Stocks and Shares ISA.
The key thing about this ISA allowance is that if you put the full 3,600 pounds into an account at the beginning of the tax year, and then remove some or part of it, you cannot put this back in that tax year, so in effect that portion of your allowance is gone for good.
The advantage of the ISA is that all the interest you earn on the funds in your account is yours to keep, meaning you save up to 40% of your interest from the taxman’s hands.
On their introduction, ISAs came with an overall limit of 7,000 pounds. Up to 3,000 pounds of that limit could be saved as cash. Between 6 April 1999 and 5 January 2000, almost 6.7 million ISAs were opened. During this time almost 7.7 billion pounds was paid into Cash ISAs.
However, just a year after their introduction, the Treasury announced plans to reduce the overall limit to 5,000 pounds, of which up to 1,000 could be saved as cash, in the 2000-01 Pre-Budget Report.
On 21 March of 2000, the government then announced that the planned reduction would be “deferred” because according to Melanie Johnson, the Economic Secretary at the time, “ISAs have got off to an excellent start” and the deferral “will give what is already a successful scheme a further boost resulting in even more tax-free saving”.
Since then, ISA uptake has increased, albeit slowly, but the industry still thinks that they are underused.
Two-thirds missing out
In the 2007/2008 tax year 14.7m ISA accounts were added to. However, 49.5 million people were eligible to invest in an ISA (based on mid-2007 projection 16+ from National Statistics) in this tax year.
Plus, our calculations show that a potential 2.3 million fewer accounts will have been added to in the 2008/2009 tax year.
Hetal Parmar, Manager for Savings at Alliance and Leicester said: “The take up of ISAs has been positive over the last decade. Having said that there are still a lot of people not using them and many do find ISA rules confusing.
Campaign for simpler, more flexible ISAs
As a result, the industry is campaigning to make ISAs simpler and more flexible in the hopes that it will encourage more Britons to make use of their ISA allowance. Some are calling for a higher ISA limit to make the tax-free accounts more attractive.
“As an absolute minimum I would hope that the ISA allowance increases in line with inflation,” said Mr Raybould.
“It may be appropriate to increase the allowance further than inflation during these difficult times to encourage people to continue to save as some form of incentive,” he added.
In addition, others are calling for them to be less complicated. Research has shown that this is what many consumers are crying out for.
“What our research has found is that many people want ISAs to be simpler and more flexible and they think it will help them to use ISAs more,” said Mr Parmar.
One suggestion to improve the flexibility of ISAs has been to allow people to dip into their ISA account and top it back up again so that at the end of the tax year they can have the current tax-free allowance in the account and only earn interest on that amount.
Of course, no matter what changes are made to ISAs the onus will be on the consumers of today to improve their general savings habits, including their understanding of the importance of having some money for an emergency.
Mr Parmar said: “You still need a back-up savings pot. Even putting in 10 pounds a week, or whatever you can afford.
“I always say to people, think of it as paying any other bill by setting up a standing order from your current account into your savings account; before you know it, even a small amount of money soon starts adding up to a nice little nest egg,” he added.
However, it is also important to get the next generation of savers into good habits from an early age.
Mr Raybould, said: “Like most things, getting people into a good habit early is somewhat easier than breaking our bad habits. We think there is a need to engage the youth of today to get them very much on the right path.”
It is hoped that the knowledge of financial products will increase in both adults and children as a result of the attention they are receiving in the news and on comparison sites.
Tim Hague, director of savings and investments at Birmingham Midshires, said: “The current media focus on personal finance and popularity of product comparison sites will lead to the increased awareness of savings products, making customers more financially savvy.”
The future of tax-free savings
The ISA has reached 10 years of age, but what is in store for tax-free savings over the next 10 years?
Mr Parmar said: “Tax-free savings have evolved; PEPs and TESSAs used to be there and ISAs came along after that and I’d like to think [there would be] tax-free incentives or tax-efficient incentives for people [to save] going into the future.
“As to what they look like has to depend on the circumstances at that time, so ISAs make sense today.
“In ten year’s time, who knows what might be the right incentive, but I’d like to think there would be something available for savers on an ongoing basis,” he added.
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