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New life for Isas

Changes to the tax system could help to revive investment business

It’s coming up to that time of year when investors should be making sure that they have used up their full Isa allowance for the year.

As a tax-free savings vehicles, Isas are undoubtedly an easy and cost-efficient way to save, although the incentives for investment fund Isas clearly need reworking in the interests of basic-rate taxpayer.

Last year saw sales of investment fund Isas remain at modest but steady levels, with year-end figures set to show that they almost reached the level of sales in 2004. This perhaps indicates a sign that Isa sales are no longer declining dramatically year on year and may be set for a revival now that the bear market is itself showing signs of recovery.

Furthermore, sales of unwrapped retail investment funds have enjoyed a more than healthy recovery with 2005 sales already surpassing those of 2004 by the end of the third quarter.

As for who is selling funds – 80 per cent of gross investment fund sales are going through intermediaries who also sell 18 per cent of all investment fund Isas. Salesforce/tied agents sell the most investment fund Isas (34 per cent) and sell 9 per cent of all unwrapped investment funds. And where is the money going? The most popular sectors for gross intermediary sales are the UK all companies, cautious managed and UK equity income sectors while the most popular net sectors are cautious managed, UK equity income and UK corporate bond.

Where does all this activity leave the Isa, which does need some impetus behind it following years of falling sales and which only now look set to at least halt if not reverse the decline?

As the Government gears up to responding to the Turner Commission’s report on pensions, it would do well not to forget the role of the Isa in helping people to save for retirement. Traditional pensions are not the only way to ensure that you are comfortable in retirement and what better way to supplement a pension than with investment fund Isas?

But, as already mentioned, the Isa framework needs adjustment to provide better incentives for basic-rate taxpayers and the Government’s expected Isa review this year provides an opportunity for lateral thinking and a reinvigor-ation of the incentives attached to Isas.

The Investment Management Association has been advocating a rethink of the way in which investment funds are taxed and our solution is to build on the already successful and well recognised Isa brand.

Taxation of investment funds is confusing and complex. There are two different types of tax, with several rates and reliefs offering any number of permutations.

Our proposal advocates sweeping away all of this complexity in the interests of a single savings tax for all investment funds. A rate of 15 per cent would, we estimate, be revenue-neutral for the Exchequer.

Of course, there would be some potentially negative redistribution impacts from a single combined rate. The IMA suggests that the best way to deal with this would be through a simple Isa-like allowance for investment fund savings, below which all gains – whether through income or cashing in – would be tax-free.

This would not only benefit investors but would also reinvigorate the Isa, potentially encouraging saving among those currently not saving and leave the Exchequer no worse off than it is now. Product providers would have certainty that the Isa will continue to exist for the foreseeable future.

The IMA will shortly be publishing detailed proposals in this area. In the meantime, our message remains that the Isa, once it benefits from better incentives, will be a useful savings method to supplement pensions and also a good way for those currently not saving, and with spare cash, to begin the habit.

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