The strange case of the unsold ISAs
It's a government flagship, so why are so few buying an equity individual savings account?
Sunday 04 February 2007
Welcome to the great ISA no-show.
The flagging sales of equity individual savings accounts, one of the Government's flagship investment policies, are baffling many in the industry and prompting concern that millions of people are throwing away their tax-free allowances.
In November, the sector showed a sales deficit of £3m as more people cashed in their ISAs than actually bought funds - the second time in the eight-year history of the accounts that this has happened, according to figures from the Investment Management Association (IMA). Things were less bleak in December, with sales at £107m, but these were down 16 per cent on the same month in 2005.
The last time equity ISA sales went into reverse was in September 2004. Blame then was largely laid on two factors: the abolition of an ISA perk that had allowed some taxed dividend income to be reclaimed via a "10 per cent credit", and uncertainty about the stock market among investors.
But this time around, the UK market is riding high, while the Government confirmed last week that savers are set to benefit from greater flexibility in being able to divert money from a cash ISA to an equity one. So many are at a loss to explain the lack of interest.
"It's a mystery as to whether it's a problem with the industry or one with investors," says Dick Saunders, chief executive of the IMA. "Your money isn't locked in and the returns are tax-free. Outside a pension, it's still the best deal."
Ben Yearsley of independent financial adviser (IFA) Hargreaves Lansdown thinks the current malaise is due to a mix of factors, including profit-taking by longstanding investors who have at last seen the light at the end of the tunnel after suffering when the market fell post-2000.
"Many investments have doubled since the nadir of March 2003, and in most cases funds have regained the highs of 2000 and investors are back in profit. Why wouldn't they take money out?"
With higher mortgage costs and living expenses, consumers are also preferring to pay down their home loan instead of investing in an equity ISA, he adds.
Anna Bowes of IFA AWD Chase de Vere says the low sales of equity ISAs could be down to the attractive returns on cash as interest rates climb. "You can currently get 5.8 per cent tax-free from National Savings & Investments' Direct ISA, which is the gross equivalent of 7.25 per cent for a basic-rate taxpayer and 9.67 per cent for a higher-rate payer - all low risk."
The comparative attractions of cash accounts are demonstrated in the figures. Equity ISAs accounted for roughly 4.6 million of the 9.3 million ISA subscriptions in the 1999-2000 tax year, according to research from IFA Bestinvest. "In the 12 months to April 2006, this had slumped to just three million out of 13 million subscriptions," says spokesman Justin Modray.
There are also question marks over the tax breaks for ISAs, which seem to benefit only the wealthy.
While all returns are free of capital gains tax (CGT) and income tax, everyone has a current annual CGT allowance of £8,800 in any case, which means it would take a huge sum to trigger a liability. So unless you receive a regular high income from an investment portfolio, say, or are selling a second property, your returns won't be taxed anyway.
"Assuming today's £8,800 CGT allowance increases by 2.5 per cent a year, an investment of £3,000 would need annual growth of more than 21.9 per cent every year over a 10-year period before CGT would become payable if the investment was sold," says Paul Ilott of IFA Bates.
"The benefits available to many investors are therefore only available in the much longer term, when the smaller sums grow to a size where CGT starts to bite."
Higher-rate earners also benefit from the treatment of dividend income on shares held inside an equity ISA, because it is taxed at the basic rate. Again, though, there's no benefit for lower- to middle-income earners. (Compare this with money inside an ISA investing in a corporate bond fund. Here, all interest paid out is tax-free, so everyone gains.)
"Many individuals receive no tax benefits from being in an equity ISA, but there is still good reason to invest in one," says Patrick Connolly of wealth manager JS&P Towry Law.
"In the long term you could have capital gains tax concerns," he explains, or it could be worth having an ISA just to avoid the hassle of putting income payments on a tax return.
Mr Connolly says that talk of the equity ISA being in crisis is unfounded, but he adds: "It has been oversold in the past.
"Those individuals with significant levels of debt, particularly on high interest rates, should not be investing in ISAs; they should concentrate on paying debt off. Those with low levels of wealth should concentrate on building up cash savings before investing in other asset classes."
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