Personal Finance: Individual Savings Accounts

The amounts that can be invested in cash-based Individual Savings Accounts, which will take over from Tessas, are too small to cover costs and pay a good enough rate of interest to attract small savers

THE DECISION to hold interest rates unchanged at this week's meeting of the Economic Policy Committee is welcome for several reasons, not least because it has helped bring down the exchange rate and promise some relief to hard-pressed exporters.

It will also prevent a correction in the property market which, according to most reports, is looking finely balanced outside London.

Things are not looking too good, however, for cash-based Individual Savings Accounts, which are supposed to take over from Tessas next April.

When the detailed proposals were announced last autumn, they were criticised on the grounds that an annual limit of pounds 1,000 on the amount that could be invested was too low, and many savers would, therefore, be tempted to put more than they should into equity-based ISAs (which replace PEPs) where there was a significant risk of their capital shrinking in value, at least in the short run.

Events of the last month show the risks only too clearly. The FTSE 100 index has now fallen by just over 10 per cent from the all-time peak it reached barely a fortnight ago. By some definitions that rates as a correction, if not yet a full-blown bear market.

For most investors, of course, to save pounds 1,000 a year is quite a large sum after paying domestic living expenses, yet a higher limit is desirable for many prudent people who could save more than pounds 1,000 a year, but who would not want to put money into equities.

Moreover, banks and building societies, stores and supermarkets, which are expected to offer cash-based ISAs, need a higher average amount in the accounts to help keep down charges. This is absolutely crucial if the providers of cash-only ISAs are to cover their costs and still offer an attractive rate of interest to savers.

The average cost of running a cash ISA is estimated at nearly pounds 20 a year, compared with pounds 10-pounds 15 for administering a Tessa. This is mainly because, unlike a Tessa, savers can put money in and take it out of an ISA at any time without losing the tax benefits, and this inevitably increases costs.

But the tax savings on a cash-only ISA account containing pounds 1,000 and earning 7 per cent interest would only be pounds 14 a year to a standard-rate taxpayer compared with a conventional account paying interest gross.

At the moment, then, the sums just do not add up. No wonder that although the research organisation Datamonitor thinks that supermarkets are ideally placed to offer cheap cash-only ISAs, both Sainsbury and Tesco have decided not to offer them in-store where savers want them.

If cash-only ISAs are to offer the instant access which is essential to attract small savers, and also allow the providers to cover their costs, they may start by offering at least 1 per cent below the market rate of interest.

Some market research companies claim that insurance companies could enter the market for cash-only ISAs, using ATM machines and retail stores as outlets and subsidising the accounts by cross-selling more profitable products like pensions to their ISA customers.

But rather than relying on cross-subsidies, it seems more sensible for the Treasury to increase the amount individuals can save and hold in a cash-only ISA, both to hold down average management costs and make sure the interest rate is competitive.