Isas quickly gained popularity with investors from their launch in 1999. Designed to replace Peps and Tessas, Isas offered the flexibility to shelter a wide range of investments from capital gains tax.
Combined with a guarantee that the product would be available for a minimum of 10 years, Isas made an attractive long-term investment option both for experienced and new investors and, within four years, around 14 million people had subscribed over £100bn.
Many financial services companies have heavily promoted Isas, particularly in the run-up to the end of each tax year, so that the Isa season has become well established in the first three months of each year. As an indication of how significant this business is seen to be, some brokers have even offered subscribers the opportunity to open accounts right up until the deadline of midnight on April 5.
However, the last couple of years have seen falling subscriptions and marketing by providers has declined. This decrease in popularity has been attributed to a number of factors, including underperforming stockmarkets and the Iraq war, but it could also be a reaction to the planned changes to tax credits.
Over the last five years, Isas have offered a tax credit on dividend income but this benefit will be lost from April 6, 2004. Although the main advantage of an Isa has always been shelter from capital gains tax, removing the dividend tax credit – currently worth 10 per cent – will certainly make investing in an Isa less attractive for those seeking income.
It is difficult to quantify the impact of such a change but research carried out by the Pep and Isa Managers' Association suggested that reducing the tax benefits of Isas could reduce the number of customers investing in these products by up to two-thirds.
Today's Isas appeal to investors whatever their level of income but the loss of the tax credit leaves a product that is simply a shelter from capital gains tax, effectively penalising smaller savers who may not make gains in excess of their annual allowance.
The withdrawal of the tax credit also penalises long-term investors who have built up a significant portfolio over many years and now rely on dividend income. As the change also applies to Peps, this will affect many older investors.
Arguably, even more important than the actual impact on Isa contributions in 2004 is the message to savers from the Government as it removes the tax credit.
For most Isa investors putting money aside today, the loss of the tax credit will have a relatively small impact on the return they can expect to see from their investments. The real issue is that we cannot afford the consequences of removing incentives to save and invest.
According to figures produced by the ABI last year, there is a £27bn annual savings gap between what we currently save as a nation and what we should be putting aside for a pension income equivalent to 50 per cent of our salaries. This means we need to be making far more provision for our futures than we are currently doing.
If the overall trend of declining savings and investments is to be reversed, the Government needs to think carefully about how to increase awareness of this issue and give us real incentives to save. Rather than removing the dividend tax credit on Isas, it should be enhancing the financial rewards for savers who take out plans such as these.
More important than the financial impact of the tax credit removal is the impression it gives that long-term savers and investors are not being rewarded for their efforts. At a time when we are making less provision for our futures than ever before, this is clearly a problem that needs to be addressed.