The Individual Savings Account (ISA) turns 18
It may feel as though it has been around forever, but in 2017, the ISA turned 18. There’s never been a more compelling reason for opening one and for considering a stocks and shares ISA. Here’s why.
According to the most recent statistics, Brits have saved a collective £585 billion in Investment Savings Accounts (ISAs), collecting billions of pounds in tax-free interest every year. Since Gordon Brown introduced the ISA in 1999, the investment vehicle has undergone a slew of changes. Over time, the annual allowance has risen from £7000 to £20,000, and a series of new ISA structures have made tax-free savings available to first-time buyers, pension savers, and savvy, risk-aware investors.
However, despite the enormous popularity of the ISA structure, most of us are still stuck in a cash ISA rut. By the beginning of 2017, around 80% of all ISA savings were held in cash accounts, despite the fact that most of these accounts were paying less than 1% in interest.
In the 2016-2017 tax year, ISA contributions fell by £18 billion compared with the previous year, largely due to falling interest rates for cash ISAs. Earlier in 2017, it was revealed that the average cash ISA rate fell to an all-time-low of 1.04%, with one bank offering just 0.01% on its instant access Cash ISA account.
By comparison, stocks and shares ISAs have been able to benefit from the strong performance of the stock market over the past two years, sparking a movement away from cash accounts and towards stock market-tracking funds such as ETFs. And more recently, the Innovative Finance ISA has capitalised on the growing demand for high yield investments by opening up the world of alternative finance to tax-free savings.
The history of the ISA in a timeline
- 1999: The birth of the ISA
The ISA was officially unveiled during, then Chancellor, Gordon Brown’s 1999 budget. The stocks and shares ISA replaced the existing Personal Equity Plan (PEP), while the cash ISA was brought in to usurp the Tax-Exempt Special Savings Account (TESSA).
Unlike PEPs and TESSAs, the ISA allowance would reset every year, allowing savers to take advantage of changing interest rates and competitive deals. However, it was not without its critics. Under the previous PEP scheme, savers had a tax-free allowance of £9000, while the new ISA only allowed for £7000 in total ISA savings, with a £4000 maximum for stocks and shares ISAs, and a £3000 maximum for cash ISAs.
- 2006: Ed Balls overhauls the ISA scheme
Seven years later, Economic Secretary to the Treasury, Ed Balls, announced that he would make the ISA scheme permanent. The process was also streamlined, allowing investors to roll their PEPs, TESSAs and some other savings schemes into an ISA wrapper. Balls also made it possible for savers to transfer money between a cash ISA and a stocks and shares ISA.
- 2008: The ISA allowance is increased
In the midst of the global financial crisis, Chancellor Alistair Darling pledged to increase the ISA allowance to £10,200 over the next two years. The new upper limit would initially apply only to people aged 50 and over, but it would be rolled out to all ISA investors from 6 April 2010.
- 2010: George Osborne cements ISA legacy
One election later, and the Conservative/Liberal Democrat coalition stood by the previous Chancellor’s plan to link the ISA allowance with the Retail Price Index (RPI), and introduce a Junior ISA for under-18s.
- 2011: Junior ISA launched
The first ever Junior ISA is officially launched, replacing the previous Child Trust Funds and allowing parents (and grandparents) to save up to £3000 per year on behalf of their children. This limit was quickly increased to £3600, to be held in cash or stocks and shares.
- 2015: Inheritance ISA, Help-to-Buy ISA, and Flexi ISA introduced
The ISA family expanded in 2015 with the launch of the Inheritance ISA, Help-to-Buy ISA, and Flexible ISA. The Inheritance ISA allows spouses and civil partners to inherit each other’s ISA savings when one of them dies. Under previous rules, all ISA savings stopped being tax-free upon the saver’s death.
The Help-to-Buy ISA was introduced as a way to ease the UK’s housing crisis, and offered a government bonus of up to 25% for first time buyers who saved between £1600 and £12,000 through the scheme.
Finally, the introduction of the Flexible ISA meant that savers could remove and replace money from their ISA accounts during the same cash year, without affecting the overall allowance.
In this same year, the ISA allowance was increased to £15,240.
- 2016: Innovative Finance ISA launched
Initially floated in December 2015, by April 2016 the Innovative Finance ISA (IFISA) had become law, allowing investors to keep all or part of their ISA allowance in the alternative finance sector – specifically, through peer-to-peer lenders and crowdfunding sites.
A regulatory backlog meant that only a handful of companies were able to offer IFISAs at the time of the launch. But by the end of the year, uptake was soaring, as some IFISA providers were able to offer double-digit tax-free returns.
- 2017: Philip Hammond introduces the Lifetime ISA
Under the new Theresa May conservative government, Chancellor Philip Hammond increased the annual ISA allowance to £20,000 and introduced the Lifetime ISA (LISA) as an extension of the hugely popular Help-to-Buy ISA. Any adult under the age of 40 is entitled to open a LISA, saving up to £4000 per year until the age of 60. Like the Help-to-Buy ISA, the government would top up any savings with a 25% tax-free bonus. However, the money could only be used to buy your first home, or to fund your retirement.
The problem with cash
Over the past 18 years, the ISA has grown in stature, value and popularity. Ultimately, it’s hard to argue with any system which offers tax-free savings through a range of varied investment structures.
However, by limiting yourself to cash ISAs, you could be robbing yourself of the best value deals. Although cash ISAs appear to be the most risk-averse option, they have been stymied by the low base rate over the past 10 years, meaning that many cash ISA savers have actually been losing value on their money. That’s because the interest rates on cash ISAs have been below the running rate of inflation, effectively meaning your savings are eroding in value.
There is so much more to ISAs than low-paying cash accounts. Investors and savers have never had more choice. Whether you are saving for your child’s future, for your own pension fund, your first home, or for capital growth, there is an ISA out there to suit you.