Should UK Call Time On 'Ineffective' ISAs?
Tuesday, May 03, 2011

A new report has questioned the utility of the UK's Individual Saving Accounts (ISAs), which alleges the system has failed to attract higher levels of household saving, with the majority of tax relief offered going to those already likely to save.

The Institute of Public Policy Research (IPPR) published its "Designing a Life-Course Savings Account: How to help low-to-middle income families save more" report on April 25, with its findings based upon research conducted over a series of workshops with low-to-middle income earners. These four workshops, in which 67 people participated, were designed to ascertain the attitudes of this sample population towards saving, and determine the most attractive features of savings products.

The report argues that, with over half of UK households having inadequate savings, the ISA regime, introduced in 1999, has failed to boost the saving ratio. This ratio, calculated as the the difference between household income and household spending, and expressed as a proportion of income, had been in steady decline until very recently. According to the IPPR's figures, between 1995 and 2008 it fell from 10.3% to 2%, experiencing something of a resurgence in the last two years, reaching 5.4% in the final quarter of 2010. However, Office for Budget Responsibility (OBR) projections show that a further decline is expected in the coming years, with the figure estimated to fall to 3.4%.

In light of such statistics, the most important conclusion made by the report is the recommendation that the government scrap ISAs, which now appear redundant. The report shows that the majority of tax relief provided under the regime is received by those who are already inclined to save. Thus, unless the government is willing to earmark additional funds to promote savings incentives, the IPPR feels that ISAs require replacement.

In order to promote a savings culture, and aid those on lower incomes, the IPPR suggests that a new "Lifetime Bonus Savings Account" should be brought in. The report states that this would be a universal deposit account, with a government "kitemark" to demonstrate it complies with a set of basic conditions and carries a full government guarantee. The account would be made attractive through the provision of an annual government "bonus", to be paid into accounts on a sliding scale, dependent upon the account's balance over the preceding three years, and capped at a maximum of GBP183.33.

In relation to tax, the IPPR suggests interest payments be tax-free, although it recognizes that, in the present fiscal climate, such a provision may not be acceptable to or affordable for the government. If this was the case, the "bonus" payment would be made in place of a tax relief. Under the scheme, four withdrawals would be permitted, before the bonus was lost, thus encouraging savers to retain funds in their accounts.

Tax relief on ISAs cost the Treasury an estimated GBP1.6bn (USD2.7bn) in 2009/10. The IBBR predicts that, were 15m people to open one of the new accounts (roughly the number of people opening ISAs at present), with a balance of GBP3,000 or more, "bonuses" of GBP183.33 paid into each account would cost the government approximately GBP2.75bn in total.

The IPPR admits that the elimination of ISAs would be unpopular with middle and high earners, who, the report states, use cash ISAs as a tax shelter for their savings, and with retired savers who have built up considerable assets in cash ISAs over time. Nonetheless, the report is firm in its condemnation of ISAs, stressing that they are a poor way of promoting or increasing aggregate savings. It is therefore felt that using bonuses to target low-to-middle income families is likely to have a greater impact.

Commenting on the findings, director Nick Pearce said: "Our research shows that people on low-to-middle incomes want simple savings accounts with few terms and conditions, little in the way of small print and paying an easily understandable reward. The current tax relief given to higher-income earners could be withdrawn without reducing their propensity to save".

He added that: "Instead, these funds could be used to increase saving by low-to-middle income families and boost aggregate saving to improve the UK’s saving ratio at no extra cost to the government. With the OBR predicting a rise in household debt, now is the time to introduce bold plans for helping people save".