Poor Rachel Reeves. She doesn’t seem to get much right – and even when she does things still seem to go wrong (see welfare reform). And so it is with her perfectly sensible thoughts on cash ISAs. All UK adults get a £20,000 ISA allowance – which they can pop into a tax-free wrapper and either hold in cash or invest in the equity or bond markets. More than 7.8 million people have cash ISAs, around double the number who use the wrapper for investing.
Reeves had been planning to change the allowance such that a maximum of £4,000 or £5,000 could be kept in cash, with the rest having to be invested. Her public thinking was simple: over the long term, the stock market provides very significantly better returns than cash – and it makes sense for as many people as possible to take advantage of those returns. History firmly backs her up on this: in the last ten years the UK’s passion for cash ISAs has, says Schroders’ Duncan Lamont, left households more than £500 billion worse off than had they invested in global equities.
The stock market has beaten cash in the long run, but also has “a better... record of doing so over every reasonable investment horizon”. It has also kept you constantly safe from inflation in a way that cash simply hasn’t: “there have been no 20-year periods in our analysis when stocks lost money in inflation-adjusted terms”. This is not to say that people don’t need to hold some cash. They need around six months’ worth of household expenses.
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Most people won’t need an ISA at all for that. Lower-rate taxpayers already have an annual tax-free allowance of £1,000 on income from savings. That’s roughly the income from £22,000 of cash at current interest rates, an amount that makes sense as an easy-access emergency fund for most people (the average value of an ISA in the UK comes in at around £30,000). Look at it like that, and it is hard to see the value to the taxpayer (the tax revenue forgone from the ISA system comes to over £6 billion a year), or to the average saver from putting a full £20,000 allowance into cash every year. By the time you have that much, you should be investing anyway. The “fetishisation of cash” has to stop, says Lamont.
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Rachel Reeves should revive the idea of the Brit ISA
It makes sense, then, in terms of personal wealth alone, that Reeves should want to nudge savers into the stock market. But there are a few public goods attached to the idea as well. Firstly, people with more wealth will require less in the way of state handouts the UK clearly can’t afford anymore. And secondly, if less money is going into cash accounts, more might go into British equities. It really needs a little support – support that might as well come from ISA accounts supported by the taxpayer.
The truth is that if Reeves was brave, she’d not just cut the cash component of ISAs down to size (or completely). She would also revive the idea of the Brit ISA and insist that those who want the full annual allowance should be obliged to put a good 50% of it (maybe more) into the UK market. If you are getting tax relief on your investments, as my Bloomberg colleague John Stepek points out, “it makes sense for some of that to be benefiting and driving down the cost of capital for domestically listed companies and boosting the UK’s capital markets infrastructure, rather than getting pumped into the S&P 500”. The precursor to the ISA – the PEP – had a restriction along these lines, so the idea is hardly a modern madness.
Not everyone is on board with much of this (or poor Reeves wouldn’t be needing more time to consult on it). Horrified savers, presumably the ones who don’t read Lamont’s work) poured a stunning £14 billion into cash ISAs in April. Imagine what that kind of money could have done for the UK economy if put to productive use. Meanwhile, the building societies, who provide a lot of the cash ISA accounts and effectively use them as a cheap form of funding for mortgages, have been pretty vocal in their opposition too. Slashing the allowance would be all stick and no carrot, says Matthew Carter of the Coventry Building Society, penalising savers for keeping cash “and nudging them towards taking more risk with their money”. As an aside, note that Coventry is offering instant-access cash ISAs with an interest rate of 2.4%, just under half the best rate on the market. Maybe he’s missing the point on purpose?
There is an argument that cutting the cash allowance would make no difference to the amount invested. AJ Bell’s research suggests that only 20% of cash ISA holders would consider investing if the allowance was cut, and 50% would simply save the same amount into a taxable account instead. Martin Lewis of MoneySavingExpert worries about this too. He would like to see – chucked into an already overly long list of different types of ISA – something he calls a “Starter Investment ISA”.
The people who might have used a cash ISA in the past would put “say, up to £1,000 in... and as well as it being tax-free, you’ll get, for example, a 5% boost on contributions from the state (with the cost split between investment providers and the state) as long as the money is kept in investments for a set time (such as one year)”. The bung from the taxpayer would, he says, be a “sweetener”. It would be more of a pointless (and expensive) complication. The sweetener is already built into ISAs in the form of tax-free capital gains and dividends. Many say we need more education about how investment works. That’s true (and Lewis could do a lot here). But what is needed even more than education is action. Let’s say goodbye to the mostly pointless and always expensive cash ISA.
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