In the 23 years since the launch of the ISA, they have become the cornerstone of millions of portfolios, and home to an incredible £619.75 billion (in both cash and stocks and shares ISAs).
They’re a brilliant tax-saving solution for the vast majority of investors. They’re also a lifeline for many savers – particularly higher rate taxpayers and those who are hoping to build large cash balances.
Over the years they’ve evolved and improved too. Allowances have been dramatically increased, tax breaks improved, investment options widened, and there are now solutions for all kinds of savers and investors – including children, and young people looking for a hand onto the property ladder.
Of course, they’re not perfect. The expansion of the ISA range in recent years means they’re crying out for simplification. Streamlining would help people take advantage of ISAs, and avoid them being overwhelmed by too many options.
Hargreaves Lansdown’s wish list
Streamline the range of ISAs
Over the years an array of ISAs has emerged, and while choice is positive, we need a balance between offering choice, and providing so many options that it becomes difficult to select the right one for your needs. There are three products that can be rolled into existing ISAs while maintaining this balance: Child Trust Funds into Junior ISAs; Help to Buy ISAs into the Lifetime ISA; and Innovative Finance ISAs into Stocks and Shares ISAs.
In the case of IFISAs, one reason they’re separate is because you can’t have more than one ISA of each type per tax year. It means you can use the IFISA for a small peer-to-peer investment and get a separate stocks and shares ISA for the rest of your ISA allowance. If you rolled them in together, under the current rules you’d need to pick one or the other. This could be solved with the second proposal.
Allow people to subscribe to as many ISAs in a year as they like
There are no restrictions on the number of different pensions you can contribute to each year (as long as you stay within the annual allowance) so why restrict the number of ISAs? This would also iron out needless confusion – such as the fact you can’t currently put money in a Help to Buy ISA and a cash ISA in the same year.
Completely separate the ISA allowances
At the moment, you can put up to £20,000 into ISAs this year, including £4,000 into a LISA. It means anyone taking advantage of the full LISA allowance would be left with £16,000 to save and invest in other types of ISA. The sharing of the LISA and ISA allowance is the single biggest cause of confusion among people considering a LISA, and creates administrative complexity for savers and providers. Separating the two allowances would solve this at a stroke.
Cut the LISA withdrawal penalty to 20%
If you take cash out of the LISA before the age of 60 – for any reason other than to buy your first property – you face a penalty of 25%. While it may look like you are just giving up the government bonus it’s more complicated than that, because it also takes a chunk of the money you have invested too (£6.25 of every £100).
If you put £4,000 into your LISA, you would receive the 25% government top up which brings the sum of your LISA up to £5,000. If you then withdraw that £5,000 you will pay 25% on that which comes to £1,250 so you are eating into your savings.
Last year the government temporarily reduced the LISA penalty to 20% in response to the pandemic. Despite this a recent FOI showed £34m was paid in penalties last tax year – more than three times the amount paid in the previous tax year. Our own client data shows 8221 clients have paid a penalty to withdraw. The government has since reinstated the 25% penalty.
Re-think the limit on the value of the property you can buy with a LISA
A second issue is that people can only use their LISA to purchase a home worth £450,000 or less. If your dream home costs more than that, again you get hit with the penalty. Recent ONS data showed the average first time home cost £222,997 on average but for those wanting to buy in the capital they have significantly less headroom with average first-time house prices at £444,592.
The government needs to consider linking this limit to house price inflation, or introducing regional variations, to protect people who simply want to buy an average property.
Treat ISAs and pensions consistently when it comes to inheritance tax
Pensions can be passed on tax free after your death, but ISAs are potentially subject to inheritance tax. This could distort the way people view their retirement finances, and put them off saving into an ISA alongside their pension to create a valuable tax-free source of funds in retirement. The two should be treated consistently.
