The investment community were expecting an ISA cap as the main feature of George Osborne’s budget, so they were as surprised as everyone else by the annuity policy. The budget was greeted with good cheer. Not only did the cap not happen, but the annual investment limit had been raised to a whopping £15k, without the Labour party seeming to notice. What a coup!
So let’s just see how the ISA breaks down. Let’s imagine a baby called Gideon junior comes into this world to a wealthy family, who immediately open a junior ISA, and deposit the maximum £4k per year until he is 16. He then gets an inheritance and he deposits the maximum £15k per year until he reaches the retirement age of 68. How much tax free wealth will he have by that time?
Financial advisers calculate future returns as being either 3%, 6%, or 9%, depending on how optimist the client is, of future returns, or interest rates. Using the 6% figure, Gideon junior would have £107,458 by the time he reaches 16. With £15k a year added, at 6% compound interest, by the time he is of retirement age of 68, his ISA would have grown to £7,811,662.
It made sense for the City to expect an ISA cap, since the Labour Party had been speaking about ending the allowance for the upper tax band, so the whole thing was obviously being scrutinised. Osborne was looking to raise revenue, and would want to clip the wings of a potential popular Labour policy, so a cap on the maximum that can be held in an ISA, made sense.
However, the City seems to have missed the obvious political angle. Unlike pensions, where the government provides an expensive tax rebate for each contribution, with the ISA, it costs the government nothing right now, but they can’t tax the income or capital gains later, when it is withdrawn. It’s a tax break for the prosperous/rich right now, but with the loss to a future chancellor in 20 or 30 years time.
Osborne likes a flutter, and he seems to have gambled that Labour would be so thrown by the annuity reform that they’d completely miss the significance of the increase in the ISA allowance. He may also have calculated that the bingo tax break would so animate the opposition, that they would be completely diverted from the biggest tax cut for the rich that we’ve seen since the Lawson budget of 1988.
The ISA started life in 1986, as the PEP a £6,000 tax exception. Gordon Brown increased this to £10,200, during the prawn cocktail offensive, but this was still within the realms of an ordinary saver, in a good year. The increase to £15k a year puts it in a different league. The really extraordinary aspect of Osborne’s increase, is not just that it is the largest tax break since 1988, for the lucky few, but that it has been introduced during a period of austerity, while everyone else has been suffering tax increases, and many pensions have been aggressively slashed.
So if Labour were to cap the total amount that can be held in an ISA, then at what amount? I think we first need to question our reason for providing this tax break at all. I believe Gordon Brown wanted to increase the amount that the country has saved, in order that more investment is available to industry. Is that our thinking, or is it that we want people to have financial security in old age?
If it is a retirement question, then how much income do people need? I’d say that to avoid poverty they’d need an income of £15-20k per year. According to today’s low rates, you would need an annuity of £250k to achieve this. To live with comfort, a person might need £30k per year, which could be a £500k annuity.
These annuity rates are unusually low due to the effect of Quantitative Easing. However, it gives an idea of the kind of figures that policy makers should be considering. In my view, the £500k figure is the one we should be looking at.