Amid so much choice, Paul Latham offers suggestions on how to make a crowded marketplace less confusing.
Recent years have seen growing calls to simplify the Isa market. New research from Octopus Investments* shows why this idea merits serious consideration.
Despite the undeniable success of Isas over the past 20 years, there is strong evidence that people find the Isa market confusing. As a result, many are not using Isas to their full potential.
Isa rules are not widely understood
There’s no doubt that we are a nation of Isa lovers, with more than 22 million Isa holders in the UK. Yet our research reveals that many adults in the UK don’t understand fundamental rules about Isas, or what different types of Isas are for.
For example, 54% say that they don’t understand Isa transfer rules. This means that many people may be missing out on better deals they could get with other providers. It also diminishes the power of competition in the market.
This is far from the only aspect of Isas that people struggle with. Our research also found that 52% are unsure how many separate Isa accounts an individual can open, 38% are unsure how to withdraw money from an Isa and 36% don’t understand the benefits of an Isa over other savings and investment products.
This lack of understanding can have a profound impact on whether people achieve their financial goals.
Cash Isas are liked, but most fail to beat inflation
The most common reason people cite for using an Isa is to boost their savings. Yet our research finds that 66% of those who say they are looking for growth are doing so through a cash Isa. Not only that, 38% say that this is the only type of Isa they hold.
Sadly, it’s very unlikely that these savers will achieve real growth this way. The current average floating interest rate on cash Isas is 0.9%, around half the rate of inflation.
One big attraction of cash Isas is their simplicity. Of the different types of Isas available, cash Isas are the one most people say they understand.
But there is a danger that people could be using cash Isas which won’t meet their objectives if they are mainly looking for growth.
We might also see fewer such mismatches if more people understood the other Isa options available, which may be more suitable for them and better meet their objectives.
The Isas that target inflation-beating returns
The Isa that fewest people understand is the innovative finance Isa (IFISA), which was introduced in 2016 and enables people to hold peer-to-peer investments within an Isa wrapper.
While IFISAs are considered high risk and won’t be suitable for everyone, they may be a better fit for some of those who are comfortable with the risks of investing and looking for growth. That’s because IFISAs target returns that are significantly higher than inflation.
It is a shame, therefore, that 79% of people surveyed say that they don’t understand this type of Isa. There’s a very real risk here that investors are missing out on an investment that could add valuable diversification and help them meet their goals.
The case for change
So how have we got to this point? And what can be done about it?
On the first question, the primary reason is the flurry of different types of Isa the government has created in recent years. The aims may well have been laudable, but there’s little doubt the kaleidoscope of Isas we have today confuses people.
On the second question, the answer may well be very straightforward.
What if, instead of several different Isas, there was just one single Isa wrapper in which people could hold lots of different asset classes?
Something very similar already exists in the form of Sipps. Applying that approach to Isas would give people complete visibility across all their Isa savings and investments. This would make it much easier for them to monitor performance.
It would also make it a lot easier for people to move money Isa funds between different types of investment. There are many reasons why people may need to do this. One example is a change in circumstances, such as divorce, which can dramatically change someone’s risk appetite.
Another is people getting older and finding that they need inheritance tax protection.
A single Isa for every asset class would avoid much of the cost and hassle associated with transferring Isas, making it easier for people to meet their objectives.
It should not involve a huge amount of admin, either. A simple approach would be to keep existing Isas as they are, but close them to new investment. Going forward, people could use their Isa allowance to invest in a new type of Isa. One in which they could hold a diversified portfolio of many different types of asset.
That way, they won’t have to decide year by year whether to open a new type of Isa, or how much of their allowance to allocate to each type.
Our research shows that the current Isa market is confusing. It also suggests that this confusion has an adverse impact on the way that people use Isas. Simplifying the Isa market would go a long way towards helping people make more effective use of their money.
Paul Latham is head of tax products at Octopus Investments.
*Research conducted by Opinium Research 25 to 28 January 2019 among a nationally representative sample of 2010 adults.