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Why ISA reform is on the cards · On The Money

• 0:03
  Sam Benstead: Hello. I'm Sam Benstead, and this week, Kyle is out of office again, so I'm stepping in for another week to host On The Money, the weekly look at how to get the best out of your savings and investments. This week, myself and Craig Rickman, who is the personal finance editor at Interactive Investor, discuss ISA reform. Craig, thank you so much for coming on the podcast. Today, we're talking about ISA reform.
• 0:29
  I think it'd be really useful for listeners to actually first hear you run through all the types of ISAs that are available, and then we can get on to explaining why they could be in need of some reform.
• 0:41
  Craig Rickman: Sure. Yeah. So there are six ISAs in operation. There is the stocks and shares type, cash ISA, lifetime ISA, innovative finance ISA, junior ISA, and help to buy ISA. So, five of them are open to new subscribers.
• 1:00
  The one that isn't is the help to buy ISA. So, yeah, there's there's six, and I think there is some, some agreements in, in the financial industry that that's too many.
• 1:12
  Sam Benstead: And ISA reform has been on the cards for a while. We had the British ISA that Rishi Sunak wanted to introduce when he was running for reelection last year, but that has disappeared, hasn't it?
• 1:24
  Craig Rickman: Yes. Yeah. So there's been quite a few changes to the ICR landscape since Labour took power. So, yeah, as as you mentioned, the British ISO, that was, yeah, an idea from the previous government to add, an extra £5,000 to the current £20,000 ISO limit, but you had to invest in UK listed companies. So that idea was scrapped.
• 1:46
  It was thrown in the bin. I don't think that was a huge surprise, to anyone. In the autumn budget, the the government has, or chose to freeze, the limit, the 20,000 limit on ISIS until 2030, and also froze the limits on on some of the other ISA types where the limit is a bit lower. So with a lifetime ISA, you can put 4,000 pounds in. That was frozen.
• 2:10
  And the junior ISA, that's been frozen at 9,000 pounds too. So that was another change. They've also launched a consultation into the lifetime ISA to work out whether it's still fit for purpose. We'll come on to I'm sure we'll come on to a bit more about that in a bit. And then we have had some developments a bit more recently in the in the spring statement, but there were some things that happened before that.
• 2:35
  There's been a few things that have happened afterwards too.
• 2:37
  Sam Benstead: And what's your view of all this then? Are things moving in the right direction, or is it just more noise around a topic which actually most people at home feel quite confused by?
• 2:46
  Craig Rickman: Yes. So I I think it it seems to be moving in the right direction. I mean, it's still early days in the sort of labor's return to power. So, I mean, they they seem keen to want to change things up in the ISO landscape, and we hope that they're looking to change things for the better. And for the better, I mean, to make things simpler.
• 3:04
  But, you know, some of the changes and some of the the rumored reforms may not be you know, not everyone may find them welcome. I mean, it is this, you know, kinda depends what happens, particularly the rumors around what could happen to cash izer limits. That's been been pretty divisive. And, again, yeah, we we we'd certainly talk talk more about that bit in a bit. So I think, hopefully, we'll be moving towards it, but we we we still need to know more about what's gonna happen down the line.
• 3:31
  Sam Benstead: I think, like like you say, the cash is the question is is the big one at the moment, and any changes will come in autumn. So the government's got six months to think about what it might want to do. But generally, its problem is is that most people so 63% of ISIS are cash ISIS, which is 25% being stocks and shares ISIS, and the government just wants more people to be investing. But actually, with this £20,000 allowance, most people seem to be actually drawn to the cash ISA, the security of a fixed savings rate, or or a variable rate, rather than investing in the stock market via a stocks and shares ISA. So I was looking at some of the numbers, and there's actually £300,000,000,000 in cash ISAs at the moment.
• 4:15
  So a huge sum, and it wants to unleash a lot of this money by encouraging people to invest and particularly to invest in The UK stock market.
• 4:24
  Craig Rickman: Yeah. So the the rumors around that have sort of focused on the cash ISA allowance and whether it will be reduced. C z bosses of financial firms have been lobbying to reduce it. The figure that's been put out there is, is £4,000. So, you know, that would be a huge reduction from the current £20,000 limit.
• 4:47
  In terms of what Labour said about this, so in the, the spring statement, although Rachel Reeves didn't mention anything about ISIS in her speech, a route around in the Red Book unearthed a bit more info about Labour's plans for the ISIS landscape. I've got it here. I'll I'll I'll just sort of read it out. So it says that the government is looking at options for reforms to individual savings accounts, ISAs, to get the balance right between cash and equities to earn better returns for savers, boost the culture of retail investment, and support the growth mission. Alongside this, the government is working with the Financial Conduct Authority to deliver a system of targeted support to give people the confidence to invest.
• 5:28
  Pretty clear there that the labor is looking to make some change, But how that change will look, we still don't know for sure. However, sort of in the in the past week, Rachel Reeves, speaking to the Commons Treasury Committee, said that she doesn't wanna rush the changes here, but said, I do think that reform would be worthwhile, and that's what we're looking at at the moment. And so, yeah, I think we'll we'll hopefully hear a lot more over the next few months and then find out, you know, a great deal more the, the autumn budget later this year. But it does seem like the cash ISO limit will reduce. It now seems a matter of how much it will be reduced by.
• 6:14
  And rumors I've seen suggest that there could
• 6:17
  Sam Benstead: be a £4,000 cash ISA limit. So if you're gonna invest the 4,000 in cash, that leaves 16,000 to go into a stocks and shares ISA or another type of ISA. What do you think about that £4,000 sum? Is that realistic?
• 6:32
  Craig Rickman: Yeah. I mean, it's the I guess the interesting thing with ISA limits and particularly the cash ISA limit is that, I mean, this wouldn't be a sort of brand new idea. Actually, if you when we look at, if you go back from when ISAs were introduced in in 1999 all the way through to 02/2014, the cash ISO limit was smaller than the shares portion or the overall ISA limit. So when the ISA allowance was £7,000, you could put 3,000 into a cash ISA. So if you wanted to use the full amount, you would have to put £4,000 in the shares type.
• 7:05
  Alternatively, you could just put the whole lot in the shares type. And that went all the way up to 2,014, and then, George Osborne, his 02/2014 budget, which was, the famous one for introducing pension freedoms, but he also shook up the the ISO landscape. So what he did was to equalize the ISO limits across cash and shares and in in increased the amount that that people could put in as well. He also allowed transfers from stocks and shares ISAs to cash ISAs. So that was quite a big change because you couldn't do it before that.
• 7:37
  So this isn't sort of it wouldn't be brand new territory, but it would be you know, we're talking about a cash ICs limit that would be far far lower than the overall limit and not half like it like it was when when that change happened. So it would be, you know, pretty radical. You cover a lot about investing, Sam. What's what's your take on on what this could mean for the investing space?
• 7:58
  Sam Benstead: I think, generally, it's very exciting. I think everybody should be investing, and there's a real lack of appetite for it among among some people. I see friends and family that have no idea what to do when it comes to investing, and they stick to cash ISAs when really over the long term, they'll be much better served by by using stocks and shares ISA. But just reducing the cash ISA limit and forcing people to use stocks and shares ISA comes with lots of difficulties. I mean, firstly, I don't think people understand what a stocks and shares ISA actually is.
• 8:30
  They see the word stocks and shares, which actually just mean the same thing, and they're immediately confused, and then they have to decide what they actually want to invest in. And the implication is that they have to buy stocks. They have to buy shares, and that is a risky thing to do. People won't know where to start. So, actually, I think this has to come alongside a lot of financial education, which obviously we believe in here at because people need to understand the range of options they have available to them when they move money into stocks and shares ISA, and this can range from actually just leaving cash uninvested, which I think a lot of people don't know they can do.
• 9:06
  They don't actually have to invest. They can open an account and leave cash in there. And if they wanted a secure bank account style return, they can look at money market fund. If they want us to be a bit less risky, they can invest in bonds. They can look at equity funds.
• 9:20
  They can look at investment trusts. And then finally, individual shares if they wanted to take a little bit more risk. But just pushing people to open the stocks and shares ISA and leave the comfort of a cash ISA is a big deal, and it has to come alongside education.
• 9:34
  Craig Rickman: Absolutely. Yeah. Yeah. I couldn't agree more. I mean, there's there's no guarantee that it will, you know, dramatically increase flows into the stocks and shares version.
• 9:41
  And, yeah, I mean, if if people don't appreciate the merits of investing and, also the risks as well, in in stocks and shares over the long term, then then squeezing the cash ISO allowance might only go so far. So, yeah, there's this educational piece alongside it, which I guess the government hopes to achieve with this targeted support regime that was flagged in the the red pages of the, of the spring statement. So, you know, just this is a way, for financial providers to guide people towards suitable retirement, not necessarily not just retirement or suitable financial decisions and products. So whether that's what to invest in or what pension options to choose. So I think the government hopes that this will be a big factor too.
• 10:22
  And what
• 10:22
  Sam Benstead: do you think, Craig, about people who might have invested in cash ISAs? They see the limits now drop to 4 or £5,000, and then they decide not to move the money into the stocks and shares ISA and actually leave it outside of the tax wrapper, what kind of taxes would they be paying on any income earned from their savings?
• 10:39
  Craig Rickman: Sure. Yeah. So so if you keep your money in in cash savings, then then income tax is applicable. There is a savings allowance, which so wouldn't say everyone gets. Not everyone gets it.
• 10:51
  Most people get it. But there's different amounts depending on which tax band you're in. So if you're a basic rate taxpayer, you get a thousand pounds. You can earn a thousand pounds in interest every year and pay no tax on it. If you're a higher rate taxpayer, so if you earn more than a bit smidgen more than 50 k a year, then you get £500.
• 11:09
  And if you are an additional rate taxpayer, so if you earn over a hundred and 25,000, a hundred and 40, then you don't get a savings allowance. So, basically, what it means is if you are a basic rate taxpayer and you've got more than £20,000 in savings, then you're likely to pay some tax on what you earn. If you're earning more than 50,000, that would be £10,000. And then, obviously, if you earn more than a hundred and 20 5, you pay tax on everything. So if you have significant sums in savings, then it means that you you are or could be hit with, you know, a sizable sizable tax bill, and that's something to watch out for.
• 11:46
  But that's you know, whether, you know, people will then think, well, I'll I'll invest more in the stock market to avoid paying that tax is is another thing. So, you know, time will tell with that, and, also, you know, we will wait to see exactly what labor does with this.
• 12:02
  Sam Benstead: I think education on investing and how you can build wealth over the long term using the power of compounding is is really, really key. At II, we have a annual ISO millionaire report. Everyone there is investing, obviously, and mostly it's in equities, lots of investment trust. And although there will be drawdowns, I mean, we're recording this days after Trump's tariff announcements, Equity markets are down 15% in some cases. Over the long term, it's proven that equities return more than cash, they return more than bonds, and sticking it out, investing regularly is a key way of building wealth.
• 12:36
  If more people understood this and made the most of their stocks and shares ISA allowance, then overall, people would be wealthier and more comfortable in their finances. That being said, I mean, we all know the power of investing. Cash ices do play an important role, don't they? What if you're saving for a house deposit? What if you're in retirement?
• 12:57
  So would there be a bit of a gap if we got rid of this product, Craig?
• 13:00
  Craig Rickman: Yeah. I think that's the thing, isn't it? The the cash ices when when you're looking at the longer term periods, you know, shares and stock markets typically outperform cash. But when, you know, if you if you'd have or you're looking to meet short term needs for emergencies, then that's where cash has a really, really role to play because you wanna be taking investment risk off the table. You wanna know that that your capital is secure from the ups ups and downs that you would be exposed to in the stock market.
• 13:30
  So if you need any money for short term purchases, holidays, a new car, or as a safety net for for an emergency and unexpected unexpected expenses, then cash is the right thing to do. And I think also that, you know, some people are a bit more cautious by nature. You know, they they may still invest in in an ISA, an stock option shares ISA, or their pension. But might wanna keep a large buffer for sort of their their peace of mind. You know, attitudes to investment risk are personal.
• 13:56
  I mean, the agreement is that we will need to take some risk in our portfolio over long periods to protect against inflation. But, you know, some people are happy to stomach a lot of risk, and others prefer to taking a bit less. There's no right answer here. But, you know, holding, you know, an amount in cash ices, whether you're in retirement or saving up for any sort of shorter term goals, it can have a really, really important role to play.
• 14:21
  Sam Benstead: Absolutely. And I'd encourage people to look at money market funds if they were looking for a cash like return from a product available inside of a stocks and shares ISA. So these are just funds where you pay a professional fund manager to achieve a cash like return for you. So they put your money in bank accounts, and they use other money market instruments, which for which which deliver an instant return for them, as well as using things like very short term bonds. So all of those are available inside of the stocks and shares ISA, and I think many people are aware of that.
• 14:51
  So for next to no risk, you could actually get about four and a half percent currently from money market fund products, and the one that seems to be attracting the most attention is the Royal London Short Term Money Market Fund. It's been one of the top funds over the past couple of years on our platform. Let's move on to the Lifetime ISA, the LICA. So, Craig, what is this product?
• 15:14
  Craig Rickman: Very good question. So it is, so it's a type of ISA that has a dual purpose. So it's designed to be used for pushing down a deposit on a first home, or for your retirement. So if you don't use it to to buy your first home, then you can leave it till age 60 and then take it out then for you know, to fund or help fund later life. But it was launched back in 02/2017, and there's been a, you know, a bit of controversy around it.
• 15:48
  I guess you've got these these sort of dual purpose, but it you know, the argument, it doesn't make a particularly good fist of either, which I'll come on to shortly. But, anyway, the the treasury select committee in January launched a consultation to find out whether it's fit for purpose. And so, you know, we'll find out more soon about what's gonna happen. I guess, you know, they could scrap the idea. They could or or scrap the the product.
• 16:17
  Sorry. They could reform it, or they could leave it as it is. I don't think they'll leave it as it is. There will be some change whether that means it gets kiboshed or improved. So that consultation is is ongoing at the moment.
• 16:28
  So, hopefully, we'll learn more about what's going on with it.
• 16:30
  Sam Benstead: And what are the good and bad things about a lifetime ice to them?
• 16:33
  Craig Rickman: Yeah. So let's start with the good. So you can get a 25% bonus every year up to a thousand pounds. So you can invest £4,000 in a LICA, a lifetime LICA every year. So if you invest £4,000, you essentially get it topped up to five.
• 16:50
  So that's great. Free money, plus any interest in growth is tax free. So you you can invest in different types of life. So there's two, essentially. So there's a cash type and stocks and shares type.
• 17:00
  You can pick which one you want, which again will probably boil down to your investing time frame. So if it's short and you're looking to buy a house in the next few years, then you may wanna opt for cash. If it's longer, perhaps if you're using it for your retirement, then the share type may be more appropriate. So that's a good bit. So but, essentially, it means that then when when you take the money out, eventually, whenever that is, you get to keep a lot, other than the investing charges you might pay.
• 17:24
  So that's great. That's a good bit. Onto the drawbacks, and there are a few here. So when it comes to buying your first home, the property value has to be £450,000 or less, and that value has been fixed since the Lifetime Isle was launched in in 02/2017 despite rising property prices. So and I guess it depends on where you live in the country, but if you're if you're living in London, looking to buy in London, that might not be enough.
• 17:52
  And so that's a a huge problem and one that the the treasury select committee is looking at. Another issue is that you can't take one out after age 40. So if you've taken one out before 40, you can continue to pay into it. But if you're older than 40, you can't take one out. You can't pay into one beyond age 50.
• 18:10
  So it doesn't really function as a retirement savings product either in that respect. And the the sort of final drawback, I guess, and this is one of the big ones, is if you don't use the money for either purpose, you not only lose the bonus, but also get slapped with an extra 6.25% penalty. And they have these penalties have a lot of people have been been paying these. So so lifetime ISA early withdrawal charges totaled 75,000,000 in the 2324 tax year according to HMRC, which is less than ideal. Hence, why it's currently being looked at, and there's gonna be some yeah.
• 18:50
  A big decision about what happens with it, and it will be a big decision. So I guess they're gonna I don't think it's a decision they're gonna rush, but, you know, at at some point, we're gonna find out what they're gonna do.
• 18:59
  Sam Benstead: And what's your best guess of what they might do in in in autumn, say? Are they going to continue the product, but maybe allow you to buy a more expensive home on it, or do you think they might get rid of it altogether?
• 19:12
  Craig Rickman: Yeah. It's a really good question. I'd I'd I think I I don't think they will leave the product as it is. I think that that is almost certain. So the the big decision is is to reform it, and that and that reform would probably take the shape of allowing people to to continue to make contributions after age 50, raise the property price.
• 19:29
  And I guess not just raise the maximum property price, but then raise it every year thereafter. It needs to keep pace with with rising prices in the future. And then also do something about the penalty to make sure that that people aren't worse off if they need to access it early. Because that's the problem. Is it?
• 19:45
  I mean, if you were looking to use it to buy your first home, and then the home you're looking to buy is worth more than 450,000, then you're gonna have to take the money out early, suffer the penalty, which is less than ideal, and that's gonna eat in to your deposit to buy the house that you want. So I think that they're gonna be the big decisions. I think if I had to choose between the two, I think they will probably reform it. But, yeah, I I really, really don't know. It's but it's it's a it's a massive call.
• 20:13
  So in terms of ISA simplification, if you were in charge, Sam, and you could pick three things to change about the tax wrapper, what would they be?
• 20:25
  Sam Benstead: That's a great question. I'd I'd first just say that ISAs are are brilliant. We're actually really lucky, I think, as a country to have such a generous savings allowance where the gains are free from the tax man, and it's quite hard, I think, for the government to claw those gains back. So it's a it's a brilliant product, but there there definitely does need to be some reform. And I think for me, the glaring issue is that there's too many people using this to own cash products and not enough people using it to invest.
• 20:56
  So to help solve that, I think one of the first things you could do is perhaps rename the stocks and shares ISA, which I think is just confusing and a bit jargony, and you could call it something like an investment ISA. I think that's way more straightforward. In terms of the allowance, I think Rachel Reeves is onto something here in terms of reducing what you can invest in a cash ISA. So maybe if that goes to $50.50, that could be a good thing to see. So £10,000 is allowed in cash every year and £10,000 the other £10,000 could be invested in the stocks and shares or investment ISA.
• 21:29
  I think that'd be a very interesting move and would definitely encourage people to invest more. And the final thing I'd say is that Rachel Reeves wants more people to invest in UK shares. So pushing people to put more money into stocks and shares ISAs doesn't necessarily achieve that. You can invest in US shares, cash products, bonds, funds that invest in companies small over the world. So there's no obligation in a stocks and shares ISA to own UK assets.
• 21:58
  So one thing she could do to encourage more investment in The UK stock market is to cut stamp duty, which is naught point 5% on your purchase transaction on UK shares. So she could actually cut that for retail investors inside of the ISA wrapper. So therefore, more money flowing to ISAs, more of that would actually flow into UK shares because they'd be cheaper to buy. Craig, are there any changes you would make? And in the autumn budget, what do you expect Rachel Reeves to do?
• 22:27
  Craig Rickman: Yeah. So in terms of changes I would make, I think, you know, moving to a single ISA would be a good idea, one that allows you to move assets freely within the tax wrapper to suit your current needs and and your changing needs over time. I think that would make things simpler for people to understand and to direct their savings and investments to the things that are most suitable for them. So that's what I would look to do in terms of changing ISAs. What Rachel Reeves will do later this year well, it seems like she's gonna do something with the the cash ISA limit.
• 23:07
  I mean, I I still we still don't know exactly what. Again, like I was saying earlier, cutting to £4,000 would be extreme. I mean, I I personally, I'm not convinced that it would make a huge difference to encouraging people to invest their money for the future instead of save, but, you know, we will I will wait and see on that. So I think we'll get some change there, and, hopefully, we'll get an update on the lifetime ISA as well. Because I think for those who are at the moment who are perhaps weighing up whether to use the product or not with this consultation running.
• 23:43
  You know, people are gonna want some clarity and certainty about how the future looks for that product so they know if they're gonna choose it and use it, to save for their future, whether that's buying a home or for their retirement, then they know the type of product that they're investing in and what it's gonna look like in the future. So they're they're the things that I would expect to see.
• 24:04
  Sam Benstead: My thanks to Craig, and thank you for listening to this episode of On The Money. If you enjoyed it, please follow the show in your podcast app and do tell a friend about it. We have a week off from the podcast, so you'll see us again in a fortnight. If you get a chance, leave us a review or rating in your podcast app too. You can join the conversation and ask questions to tell us what you'd like to talk about via email on 0tm@ii.co.uk.
• 24:34
  And in the meantime, you can find more information and practical pointers on how to get the most out of your investment on the Interactive Investor website at ii.co.uk.