Tax-Free Saving: Cracks in the brave new world of ISAs

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IT SHOULD all have been so simple. The Government wishes to build on the experience of Tax-Exempt Special Savings Accounts (Tessas) and personal equity plans (PEPs) to encourage people, through tax relief, to raise the level of savings. It particularly wants to encourage those on more modest incomes to save. This was the thrust of the general introduction to the consultation document, published on 2 December last year, which has signalled a radical change to the country's savings industry.

From April 1999 Tessas and PEPs will be replaced by an individual savings account (ISA) offering both tax-free capital gains and dividends. These could even be available from supermarkets and post offices.

But after nearly three months of discussions, the Government's original proposals are gradually starting to unravel in the face of stiff criticism from the City, industry and computer experts.

The reason for proposing such a dramatic upheaval is not difficult to fathom. According to Treasury figures, of the near pounds 70bn paid into Tessas and PEPs, only 1.9 per cent paid into the former has come from the poorest tenth of British households, compared with 19.1 per cent from the richest tenth. For PEPs, not surprisingly, the gap is bigger still. Fewer than 1 in 100 of the poorest households, while more than a quarter of the richest, have tax-exempt share investments.

It was to correct these apparent imbalances that the Government proposed changes to the rules surrounding tax-free investment. Its most controversial proposal is the imposition of a pounds 50,000 lifetime ceiling on the tax-free amount that can be invested and a similar limit on what can be rolled over from a PEP into an ISA.

One of the biggest problems is the sheer number of PEPs and Tessas in existence. The PEP-mad investor could have as many as 11 individual policies by spring next year with the same number of different providers. Knowing which PEPs are to be rolled over into an ISA and establishing when the pounds 50,000 ceiling has been hit is likely to prove beyond the computing power of many of the big financial institutions, let alone the Inland Revenue, which would have to police it.

According to Simon Gregson, of Whole Financial Systems, IT consultants: "It could all end in tears." Many PEP providers are already under the computer cosh. The millennium time bomb and the need to adapt to any possible entry into European Monetary Union are already straining many of the management groups to the limit. Add in the need to police the introduction of ISAs and the scope for cock-up is enormous.

Others point to the impracticality of the pounds 50,000 limit, intended as a curb on the wealthy. Ministers appear to have forgotten the important part that PEPs play in house buying, while those who intended their PEP to become a core component of any pensions scheme are likely to be unimpressed.

Michael Hart, director-general of the Association of Investment Trust Companies, thinks the limit is impractical. "The Government's proposed investment ceiling of pounds 50,000 would buy very little in terms of pensions or long-term care. We recommend a limit of pounds 200,000. This is the amount that would enable a man aged 65 to buy an annuity, that is an income, of around pounds 20,000 a year."

Many industry experts think that there has been a lack of consultation between the Treasury's ISA task force headed by Geoffrey Robinson, the Paymaster-General, and a similar body considering stakeholder pensions at the DSS under the chairmanship of John Denham, a junior minister. Otherwise, the lifetime cap could have been higher to allow for pension building and paying off mortgages.

In addition, the pick'n'mix aspect of ISAs needs to take into account the ability of savers to use ISAs as an umbrella for investing in four distinctly different products: life assurance, shares, money and national savings. The varying costs of regulating each of these four potential investment strands could discriminate against the small saver, those that ministers hope to help most. If providers spread the ISA's running costs across all investors this could mean that the poorest, those most likely to have their money in simple deposit accounts and national savings, would, in effect, be subsidising the cost of regulating more complex equity and life assurance investments.

So any tax saving for the poorest would be barely worth its while. Not a prospect likely to have people queuing at the tills.