The End of the Cash ISA

By Chris Hancock on Friday 17 February 2017

OpinionAlternative Lending

Whilst cash ISAs are still a popular product with savers, due to them being easy to understand and their tax efficiency, funds are actually resulting in reduced purchasing power.

Recent research by Steve Webb, the former pensions ministers, reveals that £1,000 kept in a cash account 10 years ago would now be worth less than £900 in real terms.

The reason for this is due to rising inflation and interest rates (at an all time low of 0.25 per cent), resulting in cash ISAs not even being able to keep up with inflation.

Whilst cash is viewed as being a safe investment, this is meaningless if its real value reduces year on year. With the ISA allowance set to rise from £15,240 in the current tax year, to £20,000 in 2017/18, this could result in even higher opportunity costs for savers.

For example, the current average value stored in an IFISA account is £1,000 invested at 8 per cent for 5 years would earn a comparatively large £566.

Steve Webb is right to highlight the uncompetitiveness of the cash ISA as being an issue. However, his calls for cash ISAs to be reduced to £5,000 is not a drastic enough action. Cash ISAs should be retired altogether due to being no longer fit for purpose.

Emergency Funds Should Be Retained Via Use Of The Savings Allowance

Whilst we do agree that consumers should have emergency funds on deposit to cover any unexpected circumstances, there is little value in having these funds tied up in cash ISAs.

In the 2015/16 tax year the Government introduced the savings allowance, which means that basic rate savers can benefit from £1,000 worth of tax free interest income, with higher rate taxpayers being allowed £500.

Given the current low interest rate environment, this seems the most sensible option for funds requiring immediate access. In all fairness, the interest rates from the most competitive current accounts are not much different from the best easy access cash ISAs.

At around 1 per cent, this means that savers can have up to £10,000 on deposit which will result in zero income tax needing to be paid.

Savers Must Seek Out Options With Higher Returns

Savers should be encouraged to explore lesser known, but higher yielding options for excess funds they do not wish to hold on deposit.

Whilst stocks and share ISAs can offer higher returns over time, the current economic climate is volatile so this creates increased risk. By acting on portfolio theory, investors should invest the proportion of funds in stocks and share ISAs that they are comfortable with losing. This is a much higher risk option but can also generate higher returns if the market works in your favour.

The IFISA Is A Synthesis Between Investing And Saving

This creates an enormous opportunity for the Innovative Finance ISA (IFISA), which can generate an APR estimated of 8.7 per cent, tax free, on qualifying P2P platforms.

Whilst both the cash ISA and the IFISA result in tax free savings, they are very different products. Cash ISAs are guaranteed to secure a negligible return of around 1 per cent, whilst IFISAs result in higher returns based on businesses paying back lenders.

Savers need to get into the mind-set of becoming investors, and taking calculated risk, by allocating their funds across a range of different businesses in different sectors. Within a balanced portfolio this lower risk, and steady returns option can compliment the unpredictable returns of a stocks and shares ISA.

Graduate Millennials, earning a salary between £30k-£45k, may choose to weight a greater balance of their portfolio in the IFISA, to withdraw in the medium term to help them make up a deposit.

Policy

Whilst it is encouraging that the Government is widening the array of tax efficient vehicles on offer for savers, and increasing the ISA allowance in 2017/18, they should also take responsibility for helping to educate savers about the differences between different products on the market.

Banning cash ISAs or penalising savers for retaining funds in them may be considered a drastic option but such actions would encourage people to look after themselves and ultimately result in the Government making savings in the long term. 

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