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Isas aren’t working, says new research

Low earners don't benefit from tax-free savings

Isas aren't working

A think tank believes that Isas aren’t helping people save enough and should be scrapped

Despite widespread popularity, Individual Savings Accounts (Isas) have failed to close to the UK’s huge savings gap, according to new research from a political think tank.

A paper from the Institute for Public Policy Research (IPPR) argues that despite the billions that the government spends on providing tax relief through Isas, more than 60% of the tax breaks goes to higher-rate taxpayers, the wealthiest in British society.

The IPPR suggests that Isas should be scrapped and replaced by a new Lifetime Bonus Savings Account, which will pay savers bonuses if they hold on to their savings.

What is the extent of the UK’s savings gap?

The saving ratio is calculated as the difference between your household income and your household spending, expressed as a proportion of income. Since 1970, the UK’s saving ratio has averaged 7.5% in the UK but between 1995 and 2008 it declined steadily from 10.3% to just 2%, although at the end of last year it had risen again to 5.4%.

However, the government’s Office for Budget Responsibility forecasts, published alongside the 2011 Budget, showed a decline in saving over the next few years with the expectation that the saving ratio will fall to 3.4%.

Why aren’t Isas working

There are over 20 million people currently with Isas in the UK. According to research from Which?, 18.6 million have a cash Isa, and seven million have a stocks and shares Isa. However, the IPPR believes that just under 11 million of those with Cash Isas are higher-rate taxpayers.

According to the IPPR research, only 31% of families with a weekly income below £600 (£31,200 per year) have an Isa, while for families with a weekly income below £400, this drops to 27%. Just 24% of those with a weekly income below £200 hold an Isa. 

Furthermore, the research shows that almost half (44%) of families with a weekly income below £200 have no savings at all, while another 16% have savings of less than £1,500.

Recent academic studies have also found that tax relief was the least attractive financial incentive for people on low incomes to start saving.

Should the government replace Isas?

The Institute believes that current tax relief given to Isas should be cut, given that it tends to only benefit the wealthiest. It states that the government should redistribute this to focus on encouraging low to middle earners with a new Lifetime Bonus Savings Account. The IPPR says that the scheme will cost the Government £2.75bn, more than the £1.6bn Isas cost. 

IPPR recommends that the government pay an annual ‘bonus’ into accounts on a sliding scale, dependent on the average balance held in the account over the last three years, up to a maximum of £183.33:

  • On the first £1,000 = £1 for every £10 (ie a maximum of £100)
  • On the second £1,000 = £1 for every £20 (ie a maximum of £50)
  • On the third £1,000 = £1 for every £30 (ie a maximum of £33.33)
  • Amounts above £3,000 = Nothing

Unrealistic proposal

Gareth Shaw, investment researcher at Which? Money believes that the IPPR’s proposals are unrealistic and potentially damaging to millions of consumers. 

‘Since Isas were introduced to replace Tessas in 1999, their popularity has soared, and their simplicity has allowed millions of people to save money. 

‘While the IPPRs research does create a picture of a poor savings culture among lower earners, Isas as a product and concept cannot be held to blame for this. And the alternative it has suggested is too complex to implement.

‘Furthermore, by removing the tax relief from Isas, thousands of retired savers could potentially see their income dramatically reduced. The government has put its faith in Isas, aiming to increase savings limits annually with inflation. We believe they’re here to stay.’

What do you think of Isas? Should they be scrapped? Have your say on the Which? Conversation.

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