ISAs are too complicated. This has been an emerging theme over the last six months, with several independent bodies commenting on the growing level of complexity in the ISA landscape. This has come in the form of new rules (flexible ISA, additional permitted subscriptions) and new ISA types (Innovative Finance ISA, Help to Buy ISA, Lifetime ISA). New rules and ISA types means more options for investors.
As we’ve seen with pensions, however, an increasing ‘complexification’ could lead to fewer people saving and investing tax-free for their future. This is not in the interest of the government if it ends up footing the bill, nor is it in the interest of individuals if they suffer a lower quality of life in later years as a result.
It’s for these reasons that I wholeheartedly agree we need to get ISAs back on a simpler footing, not least in respect of the Lifetime ISA. How do we do this? Here are four suggestions for starters.
1. Remove the ‘one ISA of each type per tax year’ rule
The more you think about it, the more it seems like an obvious change. If an investor saves within the £20,000 limit, why does it matter how many ISAs they put their money into?
This might create an additional reporting burden, but nothing that should trouble ISA providers or HMRC given current electronic capabilities. The burden would also be offset by having fewer ISAs to repair at the end of the tax year.
2. Make the Lifetime ISA purely for first-time buyers
Individuals looking to put a bit of money aside tax-free used to have a nice, neat binary choice between an ISA and a pension.
That was until 2017 and the arrival of the Lifetime ISA – a peculiar hybrid between an ISA, a pension and a home savings product.
For younger savers, this has complicated the decision-making process. This is a concern because it increases the danger of their making a choice they later come to regret, particularly if they forego ‘free’ employer pensions contributions in favour of funding a Lifetime ISA.
3. Reduce the charge on Lifetime ISA withdrawals from 25% to 20%
I don’t think there should be any kind of penalty for tax-incentivised savings, and reducing the charge to 20% so it matches the initial bonus would remove the punitive element.
This also simplifies the rules by removing the need to legislate for ‘life events’, which are the events following which you can make charge-free withdrawals. It also dovetails neatly with the previous suggestion.
4. No transfers from ISA to Lifetime ISA
At present, the £4,000 Lifetime ISA limit is technically separate from the £20,000 ISA limit. However, a subscription into a Lifetime ISA will use some of both allowances.
A transfer from an ISA to a Lifetime ISA will not use any of the ISA limit, but it will use some of the Lifetime ISA limit, even though it’s not a subscription.
This is more confusing than it needs to be, and it makes it difficult for investors to keep track of how much they can pay into which account.
Let’s simplify this. Bring the Lifetime ISA limit of £4,000 fully within the overall £20,000, but remove the ability to transfer from an ISA to a Lifetime ISA.
These are just four suggestions, and I’m sure there are others. Either way it’s clear we need to start reversing the trend so we can get the ISA back to the simple product that made it successful in the first place.