Will the new ISAs revive our interest?

ten pounds

A NEW type of ISA for people under 40 has been revealed by the Chancellor, in the hope of helping them save for a home or pension by providing a 25% bonus.

The Lifetime ISA - which becomes available in April 2017 - will allow savers to pay in up to £4,000 a year, with an annual bonus of up to £1,000 paid by the Government, until the account holder reaches 50.

Regular ISAs are getting a makeover too, with the annual investment threshold being raised from raised from £15,240 to £20,000.

Saving for a deposit

The Lifetime ISA (LISA) with its yearly 25% bonus, can be accessed penalty free on just two occasions. The first is if the account holder uses it to buy a first home worth up to £450,000.

Those already saving in a Help to Buy ISA - only introduced last year - will be able to transfer their savings into the LISA.

Alternatively, savers must keep the money locked away until they reach 60 in order to access it penalty free. The idea behind this is that the money will provide a boost to our pensions.

As an example, paying £800 into a LISA would deliver £1,000 - plus investment growth - when withdrawn after 60.

In this respect, the LISA is an echo of the proposed, but never realised, Pensions ISA, which would have changed the way pensions were taxed.

At the moment, contributions and growth are tax-free, but withdrawals are taxed as income - but under the Pensions ISA, contributions would be taxed, although growth and withdrawals would be tax-free.

Saving for our pensions

George Osborne backed away from the idea following widespread criticism of the proposals from campaign groups, financial providers - and the media - who expressed concern that it could result in a net reduction in savings.

The International Longevity Centre (ILC-UK) suggested that there was a "very real" risk that people would save less in a Pensions ISA because they didn't trust the Government to honour their promise to allow withdrawals to be tax exempt in 40 years' time.

By contrast, the LISA is designed to work in conjunction with a regular pension.

The Government say that they will continue providing the bonus of 25% of the amount invested each year until the saver reaches 50.

But to prevent people from attempts to cash in on the generous bonus for some other purpose, they say that they will reclaim the value of that bonus, plus accrued interest - and charge a 5% penalty - if account holders withdraw their money before they reach 60.

Like saving for a home, we're not doing very well at saving for our dotage - estimates suggest that the majority of us need to double the amount that we currently put away.

While some might attribute this to us having too little money to spare, the Government appear to think that it's down to the unappealing savings products offered to us.

Not interested

There is a kernel of truth in this - we've been turning away from ISAs as their interest rates have crept ever downward.

In 2014/2015 the number of accounts opened was the lowest since 2006/2007 - unsurprising, given that the top cash ISAs in 2006 were offering a rate upwards of 5%, but by 2014 they had fallen to below 2%.

ISA interest rates, like the rates offered on other savings, fell after the worst of the global financial crisis hit in the autumn of 2008.

But despite frequent and persistent rumours that the Bank of England's base rate would start to creep back up again have come to nothing, and report now suggest that we'll have to wait until 2017 at the earliest for a rise.

In the meantime, this year has been labelled by financial analysts Moneyfacts as "perhaps the worst [ISA] season on record".

This year's average easy access cash ISA pays just 1.05%, and taken as a whole, the average ISA rate is just 0.85%.

Even the very best rate - currently the State Bank of India's 2.6% five-year fixed ISA - is worse than that offered by many current accounts.

In the past, making such a comparison would be unfair - after all, savers had to pay tax on the interest earned by their current and standard savings accounts, whereas they didn't with an ISA.

However, the introduction of the Personal Savings Allowance (PSA) means that, from April this year, basic rate taxpayers can earn up to £1,000 in savings income tax-free.

The result, say the Institute of Fiscal Studies is that "for most people, the ordinary bank account will in effect be tax free in much the same way as cash ISAs".

Who'll benefit?

What effect then, will George Osborne's ISA revamp have on savers?

With regard to the increased threshold, being able to save £20,000 a year in an ISA will obviously only benefit those who can afford to do so.

This is more than likely to be a minority of savers, if past figures are anything to go by.

Government statistics show that in 2012/2013, just 38% of people with cash ISAs contributed the then maximum amount of £5,640.

In the same year, some 41% of those with stocks and shares ISAs contributed the maximum amount of £11,280.

Whatever the type of account, people on lower incomes are far less likely to be able to contribute the maximum amount - so the increased threshold will make little difference.

This mirrors the problem with the Government's other new scheme to help us save, under which low earners on certain benefits can earn a 50% bonus on savings after two years.

The obvious problem here is that low earners on benefits are unlikely to have much to save.

There's also concern that because the LISA is simpler, people who can't afford to contribute meaningfully to both a savings account and a pension may pull out of existing pension schemes and save their money in a LISA instead.

As Huw Evans, the director general of the Association of British Insurers, says, "the test for success for the lifetime ISA will be whether it increases overall retirement savings".

That is, getting people to save, but without undermining the auto-enrolment programme the Government have spent years developing and expanding.

Analysts are already suggesting that the likely outcome will be people favouring the LISA for their pension savings.

Ian Lowes, director at Lowes Financial Management, recently told the Financial Times that it looks "likely the ISA will become the retirement savings vehicle of the future".

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