My Dad’s response to the chancellor’s cuts to capital gains and dividend allowances was: “It’s a relief that everything your Mum and I have is in pensions and Isas.” After a lifetime of diligent saving and investing, you may think the same. But will our tax-advantaged savings regime escape future austerity measures?
Pensions have been like a long game of football in which governments constantly move the goalposts. I expect proposals for a flat rate of upfront tax relief on contributions to be the next move, as it would not only raise revenue, but be fairer to those on low incomes, and has been mooted for a long time.
But surely Isas are sacred cows? Isas are fantastic, enabling investors to receive tax-free dividends and capital growth. This will be more valuable from April 2023, when the dividend and capital gains tax-free allowances are cut in half.
There are already 27mn adult Isas, with 12mn people contributing to them. Among these savers are more than 2,000 Isa millionaires, who can now generate a tax-free income of £40,000 through dividends and are not obliged to declare it on their tax returns. Investors in UK companies can expect to receive an additional £5.7bn of dividends this year because of the pound’s slide against the US dollar.
That looks like a lot of “broad shoulders” that could be attacked in the next austerity move on our savings. And there is a growing case for reform of the Isa regime.
Launched in April 1999, Isas remain popular partly because investments that were originally shut out are now admissible, such as shares traded on Aim, London’s market for less mature companies (admitted in 2013), and peer-to-peer lending (admitted in 2016).
There’s still room for improvement. Unlike taxable trading accounts and self-invested personal pensions, Isa investors can’t hold currency other than sterling. This adds costs for Isa investors trading in international markets, who have to pay foreign exchange fees — often high — for every transaction.
But not all previous “improvements” have caught on. Flexible Isas were introduced in 2016, to allow money to be moved in and out without this counting towards your annual Isa allowance, as long as the money is replaced within the same tax year. But while most of the big banks (but not all) have made their cash Isas flexible, change among the big broking platforms has been lacklustre.
Various governments have also stretched the Isa brand too far. Investors prefer the original versions. Two-thirds of accounts are cash Isas, with the bulk of the rest in stocks and shares. But other fanciful flavours such as Lifetime Isas, Help to Buy Isas and Innovative Finance Isas all have their own rules, allowances and penalties, and often overlapping features.
Understandably, people get confused about which Isa is best for their needs and the regime is crying out for simplification. But a review would provide opportunity for the benefits to be watered down.
Inflation has already undermined the annual Isa allowance, stuck at £20,000 since April 2017. Perhaps we shouldn’t read too much into this. The annual maximum contribution was £7,000 for the first nine years. Had it risen with inflation since the start, Hargreaves Lansdown estimates it would be just over £12,000. By that comparison, £20,000 feels generous.
Plus, only 15 per cent of subscribers save at the maximum, rising to 39 per cent of those with income of £100,000 to £149,999, and 60 per cent of those with income of £150,000 or more.
So the Isa allowance still largely serves richer cohorts, who are the ones the government needs to pay more capital gains and dividend tax.
I imagine the Isa tax advantage is safer than 40 per cent upfront tax relief on pensions for higher-rate taxpayers. Making the latter 30 per cent for all would be a bigger revenue raiser. But there’s little incentive to increase the Isa annual allowance, which could easily see inflation eroding its value further.
A more palatable option for a future Isa grab would be an upper limit on the Isa savings one can make over a lifetime. It would be hard to police as Isas don’t appear on tax returns and the regime is so complex. But just as when the pensions lifetime allowance was introduced in 2006, I would expect funds accumulated in excess of the lifetime allowance to be protected at the time of introduction.
The possibility is a reason to maximise your Isa holdings while you can. On that basis, the call by Martin Lewis, founder of the MoneySavingExpert consumer advice site, for millions to ditch cash Isas in favour of higher paying savings accounts may be short-sighted.
Cash Isas may look more attractive in future and you have the option to convert them to stocks and shares Isas too. I’d consider transferring surplus savings into stocks and shares Isas.
If you’re not in a position to make new Isa investments, consider transferring any investments held outside an Isa in taxable accounts. You can do this by yourself, but it might be time consuming and a bit fiddly. Plus, if you have lots of holdings, you could incur high trading charges.
“Bed and Isa” is an easy way to sell an investment and immediately repurchase it in an Isa to shelter it from dividend and capital gains tax. The sale of the investment outside the Isa will potentially create a capital gains tax liability so people often sell investments that keep their gain below the current £12,300 tax-free allowance.
Some brokers offer Bed and Isa over the phone. And some broking platforms offer online Bed and Isa services to help streamline the process, reducing both time spent out of the market and the charges involved.
Bed and Isa is counted as one transaction, so you only pay one dealing charge. AJ Bell and Interactive Investor both offer it (with £5.99 and £9.95 dealing charges on shares respectively). Hargreaves Lansdown plans to launch one at £5.95 before the end of the tax year.
It’s worth keeping an eye on platforms’ Isa deadlines — Bed and Isa deadlines tend to be much earlier than April 5. So preferably do this all well in advance.
In fact, why not put it on your Christmas admin to-do list? It could be the best festive present ever for your family.
Moira O’Neill is a freelance money and investment writer. Twitter: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’firstname.lastname@example.org