LISA0211
Written evidence submitted by the Association of Investment Companies
Future of the ISA regime
Supplementary evidence
The Lifetime Individual Savings Account (LISA) is complex, poorly targeted, and not an effective use of government resources. Efforts to mitigate problems with the LISA will not fix these fundamental flaws. The AIC recommends that the LISA should be scrapped as part of a wider process of streamlining and more effectively targeting the range of ISA products.
The AIC’s initial response to the Treasury Select Committee’s call for evidence on the LISA recommended that the Committee should widen its enquiry and consider other aspects of ISA reform. The AIC also recommended that HM Treasury should abolish the Cash ISA or significantly cut its contribution limit, for example, reduce it to £5,000. Abolishing the Cash ISA would mean stopping the establishment of new accounts. Existing Cash ISAs would continue but be closed to further contributions.
This supplementary submission explores the consumer and policy issues raised by our proposal to scrap the LISA and abolish or reduce subscriptions for the Cash ISA.
Having adequate cash savings is an essential part of being financially resilient. Cash reserves help people deal with unexpected events and should form the starting point for all individuals’ savings and investments. The government should encourage cash savings. There is value in targeting savings incentives on those with lower incomes as they are more vulnerable to financial shocks. This priority does not reduce the case for scrapping the LISA and introducing significant reform, or even abolition,
of the Cash ISA.
The government must strike a balance in encouraging savings and investment. It should encourage cash saving as a foundation of financial resilience. Once this is achieved, its policy should be to encourage long-term investment. This is required because the value of cash savings will be eroded by inflation. To mitigate this risk, people should be encouraged to consider long-term investment in assets which do expose investors to some risk, such as equities, in exchange for higher potential returns.
Investing does involve risks but so does over reliance on cash. The risks of holding investments exposed to some risk can be mitigated by diversification and making a long-term commitment to investment. This long-term focus on such assets should be underpinned by holding cash reserves. Encouraging saving and investment are complementary objectives. Current government policy provides an incentive to start saving in cash but continues to provide ongoing incentives for further savings at the expense of investment. The Cash ISA is a key reason for this imbalance. It encourages year on year holdings of cash to increase, reaching levels which outstrip the requirements for a cash reserve (even a very generous reserve). Abolishing the Cash ISA or limiting subscriptions will redress this imbalance. The LISA also distorts saving choices as it provides a guaranteed 25% return on cash on subscriptions of up to £4000 a year. It should also be scrapped. The government should instead focus on incentivising cash saving through the interest income tax allowance.
Government policy should also support economic growth. Achieving growth is consistent with helping people become financially resilient. After all, increasing the productive capacity of the UK economy will create employment. Jobs are essential to the financial wellbeing of people across the country. Also, higher levels of economic activity will maintain the government’s ability to raise taxes to support public services. Provision of healthcare, education, pensions, and other public services also protect the public from economic hardship.
The future of the LISA and Cash ISA must be viewed in this broader context.
Supporters of the Cash ISA claim it improves the financial resilience of the least well off. The AIC agrees that people who are the most vulnerable to financial shocks should be encouraged to save. However, the Cash ISA is not essential to achieve this.
A person with no income except interest from their cash savings can receive £17,570 before paying any tax. This amount is calculated by combining the personal allowance of £12,570 and the additional savings allowance, which allows a further £5,000 interest income to be received. The poorest are unlikely to amass cash savings outside a Cash ISA that would ever generate sufficient interest to attract a tax charge.
People with moderate incomes should also be incentivised to build a cash reserve. Basic rate taxpayers (earning between £12,571 and £50,270) can receive £1000 in interest before they start paying tax on this income.
A search of a popular savings website indicates that the highest interest rate currently available from an instant access ISA is 4.35%. A basic rate taxpayer can deposit £22,475 and hold it for a year to receive a tax-free income of £999 without using a Cash ISA wrapper. As interest rates fall, they could save even more in a savings account without paying tax on the interest they receive. This is sufficient for most people to create a cash reserve.
The LISA also provides strong incentives to hold cash. An individual making maximum contributions between the ages of 18 and 50 would be able to save £128,000 and receive £32,000 from the Government. An internet search indicates the top interest rate for a Cash LISA is currently 5% (which includes an initial year 1.2% fixed bonus). Like the Cash ISA, this provides a disproportionate level of government support given the other savings incentives available.
The general advice is that a person’s ‘rainy day’ fund should amount to six months of their living expenses. As the Office for National Statistics reports that median UK salary is £37,430, savings of £22,000 are likely to be more than sufficient as a cash reserve for most people.
The Financial Conduct Authority (FCA) is developing proposals to let firms provide greater support for consumers to help them make important financial and investment decisions. The conclusions of the Advice Guidance Boundary Review should give providers of savings accounts more latitude to help savers who have built a substantial cash reserve to consider investments. Reaching the limit of tax-free interest could provide a catalyst to start this process and help change investor perceptions of the benefits of investing.
The Cash ISA and LISA do not help providers focus consumers’ attention on the benefits of investment. They provide strong incentives not to shift from cash savings to investments. They offer a permanent shield from tax on interest alongside an annual savings limit that allows high levels of cash saving to be made year on year. They encourage cumulative, cash savings without any mechanism to encourage a shift in behaviour. Focussing government incentives on tax free savings accounts, with the ISA brand concentrated on investment, would help reduce investor inertia. It will allow firms to have a different conversation about the benefits of long-term investment.
If individuals nonetheless did want to continue to increase their savings, they might also consider other options such as Premium Bonds. While Premium Bonds do not pay a guaranteed income, they do offer the potential for a tax-free prize (with an annual prize fund rate of around 4%). This option may become attractive as interest rates fall (which is the current expectation) and if consumers consider that their incentive to save has been reduced because they will be taxed on any interest which they will receive.
Supporters of the Cash ISA note that “Figures from HMRC show that over 18 million people have a Cash ISA. Almost half (47%) of Cash ISAs are held by people with incomes of less than £20,000 a year, and the average savings balance is just under £13,400” (Building Society Association, Press release). Rather than underscoring the value of the Cash ISA, this demonstrates that nearly half (probably many more) of savers using Cash ISAs do not need this wrapper to receive interest without paying tax on it.
Supporters of the LISA and Cash ISA argue that they encourage saving because they are part of an established brand. This is true. However, if the LISA and Cash ISA were withdrawn (or contributions on the Cash ISA were significantly reduced) banks and, building societies would promote other options to save. These efforts would highlight how consumers can receive interest up to the tax-free savings allowance. Marketing messages would be supported by competition to provide more attractive (higher) interest rates.
Consumer familiarity with the LISA and Cash ISA as part of the savings and investment landscape does not justify retaining this wrapper. Quite the opposite. One of the reasons the government should consider scrapping these schemes is to change that landscape and consumer perceptions.
Scrapping the LISA and withdrawing or significantly limiting contributions to the Cash ISA will help achieve the government’s dual objectives of supporting financial resilience and growth. It will reduce incentives to make year on year savings in cash beyond what is required to achieve financial resilience. Creating an environment that better balances incentives to save and invest could include various policy options:
Increasing the tax-free allowance: Basic rate taxpayers can receive £1,000 in interest tax free. Higher rate taxpayers can receive £500. The government could consider increasing these amounts to support cash savings in traditional savings accounts.
This should be done at the same time as streamlining the ISA framework. The AIC has recommended limiting the ISA range to the Stocks and Shares ISA, Junior ISA, and a UK ISA. This would create a new balance of incentives between saving cash and making investments.
Publicity campaign: The AIC recommends that government accompany the reform of the ISA framework with a consumer focussed campaign to highlight other options for tax free savings and the benefits of long-term investment.
Creating a UK ISA: The AIC recommends the government creates a UK ISA as part of its approach to ISA reform. As discussed in the AIC’s primary submission to the Committee , the UK ISA would support UK stock markets’ role as a source of growth capital. It could also deliver better long-term returns to investors than cash.
Critics of a UK ISA have argued that it limits an investor’s opportunities for diversification and capacity to hold investments which may secure higher returns. They argue it could also reinforce the existing UK bias exhibited by some retail investors. These are not compelling arguments. These arguments ignore the fact that the government provides other, substantial, incentives to invest in risk exposed assets which have no geographical limitation.
Annual contribution limits to the stocks and shares ISA are £20,000 a year. The annual allowance for pension contributions is £60,000 this tax year. Very few investors exhaust these allowances. Where they do, they will have a choice. They can invest in a UK ISA (which the AIC recommends would be additional to the Stocks and Shares ISA). A UK ISA will give investors significant diversification and choice. This will support UK stock markets. It will help UK business by making a UK listing a more attractive way to raise capital. It also gives investors international exposure via UK listed companies. Among the benefits of a listing is that businesses can raise capital to enter new, international markets. Almost 80% of the revenue for FTSE 100 companies is earned overseas.
If an investor decides not to take advantage of the UK ISA, once they have used up their stocks and shares ISA allowance, they could invest in shares listed on other markets and pay tax on the returns as required. Fears that a UK ISA would concentrate investment risks are unconvincing. A far greater problem is the cash bias created by the current ISA range.
Creating tax incentives designed to support the UK economy is not a departure for government policy. Tax reliefs are provided to support retail investment in small businesses via the Enterprise Investment Scheme, Seed Enterprise Investment Scheme and Venture Capital Trusts. These tax incentives are supported across the political spectrum. Any fear that these reliefs reduce diversification are overridden by the value of encouraging investment in UK business. Also, any retail investor considering these venture capital schemes can first take advantage of the stocks and shares ISA or their pension allowance before investing in these options. The same would be true for a UK ISA.
Stamp duty: If the UK ISA is not created, the AIC recommends that the resources saved from streamlining the ISA range should be used to start the process of abolishing stamp duty on shares traded on UK stock markets. The AIC has recommended that the government set out a plan to abolish this in full by the end of this Parliament. If this cannot be achieved in one go, it should be done in stages.
Exempting investment companies as a first step should be the priority. This is justified as they compete with open-ended funds which are not subject to stamp duty. They also mobilise funds for direct investment in the UK economy and, where they hold UK shares, are double taxed, which is against the general principle that collective investments should be tax neutral. Alternatively, all UK shares could have the rate of tax progressively reduced to zero.
Using resources previously allocated for the LISA and Cash ISA would make investment in UK stock markets more attractive. It would increase liquidity and enhance the attractions of a UK listing for companies seeking to raise capital. It should increase individuals’ long term returns as compared to larger cash savings and can be done without undermining the tax incentive to start savings in cash and to maintain a sizeable cash reserve for financial resilience without incurring tax.
February 2025