The Return of the ISA

In recent years, investor interest in Individual Savings Accounts (ISAs) has waned. The most recent figures from HMRC show that, in 2020/21, adult ISA subscriptions fell by 3.2% over the previous tax year and were 13.2% lower than in 2014/15, when the overall limit on contributions was £15,000 rather than the current £20,000.  

ISA benefits

ISAs have been part of the investment landscape for over 20 years, having originally been created to replace two previous schemes, Personal Equity Plans (PEPs) and the tortuously named Tax Exempt Special Savings Accounts (TESSAs). The main tax advantages of ISAs now are much the same as they were at the time of their launch:

• Interest income is free of UK tax;

• Dividend income is also free of UK tax (but may be subject to foreign withholding tax);

• Capital gains are UK tax-free; and

• There is nothing to report on your tax return.

There have been tweaks over the years, including the introduction, in 2017, of the Lifetime ISA (LISA) for the under-40s. LISAs offer a 25% Government uplift to contributions, but suffer a penalty equal to 25% of their value if cashed in before age 60, other than to provide funds for the purchase of a first home. That penalty has limited LISA’s popularity.

It is now also possible for ISAs to be effectively transferred on death to a surviving spouse or civil partner.

So why the waning interest?

At one stage it looked as if the Government might use the ISA structure to replace the complex pensions tax regime - the LISA certainly pointed in that direction. However, a change of Chancellor saw that idea disappear and, instead, the ISA became another victim of the Treasury’s reluctance to recognise the impact of inflation. The current £20,000 overall contribution limit came into force in 2017/18 and will not increase in 2023/24.

Two other Government decisions that took effect in 2016/17 undermined the tax attractiveness of ISAs for many investors:

• The personal savings allowance (PSA) gave basic rate taxpayers a 0% tax charge on the first £1,000 of interest (higher rate taxpayers receive £500, additional rate taxpayers, £Nil).

• The dividend allowance meant all taxpayers paid no tax on the first £5,000 of dividend income (reduced to £2,000 from 2018/19).

One other non-tax aspect reduced the appeal of ISAs: rock bottom interest rates. Cash ISAs have regularly attracted more contributions than their stocks and shares counterparts, but the latest HMRC data showed a near 25% fall in fresh cash ISA contributions between 2019/20 and 2020/21.

The appeal of ISAs may go up as well as down

Last November’s Autumn Statement may not have promised any increase in ISA contribution limits, but at least it did not impose a cap on total investment, a measure which had been rumored beforehand. Indirectly, the Statement gave several boosts to ISAs by its increases to investment taxes (please see ‘2022: a taxing year’ above), some of which could well affect you:

• Cutting the dividend allowance to just £500 from 2024/25;

• Reducing the CGT annual exemption by over 75% from the same tax year;

• Freezing the personal allowance and higher rate tax threshold until 5 April 2028; and

• Creating nearly a quarter of a million new additional rate taxpayers from 6 April 2023.

The non-tax headwind faced by cash ISAs has also reversed as the Bank of England pushed up interest rates nine times in 2022. However, the rate rises have not worked their way through to many existing cash ISAs. For example, in early December 2022, National Savings & Investments was offering only 1.75% on its Direct ISA while some of Santander’s legacy ISAs paid just 0.4%.