ISAs: Time for a change

Free of much of the complexity and restrictions that apply to pensions, yet still offering an advantageous tax wrapper, the ISA has historically been viewed as a simple and effective option for saving and investing. Over 20 years since inception the product remains enormously popular, with 13 million accounts and around £75 billion subscribed to ISAs in the 2019-20 tax year.

Yet ISAs have also become increasingly complicated. Successive governments have expanded the product to try to address other financial goals, like saving for children and getting on the housing ladder. New types of ISAs have been introduced with varying degrees of success. As it stands, we now have four main types of ISAs for adults, plus two types of Junior ISAs for children, with different eligibility requirements, subscription limits, and interactions with each other.

It doesn’t come as a surprise to me when investors make mistakes with their ISAs. There are myriad ways this can happen, including subscribing to an invalid combination of accounts, or exceeding one of the various subscription limits. And whilst most ISA managers do their best to comply with the rules, inevitably mistakes can be made by administrators too. We are human, after all, and even the best designed systems can fail from time to time.

HMRC allows ISA managers to “repair” an ISA where certain rules have been broken. This means removing any invalid subscriptions or investments, as well as any related growth or income. The investor may then have a tax liability to settle in respect of those gains. Where a repair is completed successfully, the ISA tax wrapper stays intact for the remaining valid funds. This sounds simple enough, but in practice the process can be an arduous affair, requiring HMRC to review and analyse information received from ISA managers and instruct them on what action to take. Corrective action may not be taken until months or even years after the initial error occurred. This can come as a shock to investors, who often don’t realise that a rule has been broken.

Sometimes, a mistake cannot be fixed. The account must instead be voided, which means the tax wrapper is lost. This is what happened to the ISAs offered by London Capital and Finance, who promoted the sale of mini-bonds which did not qualify as eligible ISA investments.

It is the failings of London Capital and Finance which have now prompted the government to review the ISA tax compliance regime. The proposals put forward by HMRC aim to encourage ISA managers and investors to get things right first time, and ensure accountability for the ISA manager. This is an admirable goal. There is a heavy emphasis in the proposals on penalties for those who repeatedly and recklessly break the rules, but HMRC have also asked respondents to suggest other options to encourage compliance.

This review is an opportunity to modernise the ISA regime and recognise the more complex landscape we now operate in. Focus should not only be on discouraging and punishing deliberate offenders, but in easing the administrative burden where innocent mistakes have been made, and allowing them to be corrected more quickly. We may not be able to eliminate mistakes completely, but we can make fixing them much easier.

This article was previously published by FT Adviser