Our columnist casts his mind back to the birth of a savings product that has now become your own mini tax haven. Here’s why it’s so important, more now than ever before.
I remember 1987 for many reasons. It was the year I started my career as a journalist when I took a job as a reporter at monthly financial magazine Money Management (sadly, a publication no more).
It was also the year when stock markets went into meltdown – in my second week of employment. It was as if it was yesterday.
I had driven home from London to Bristol on Friday 16 October (week one) in a battered Renault 4 whose rusting bonnet was held down by a couple of resistance bands. How it did not fly off in the gale force winds I do not know to this day. How the Renault 4 stayed upright on the M4 is also a miracle.
On Monday 19 October - Black Monday as it was soon dubbed - stock markets worldwide fell like stones. How I managed in its wake to hang on to my job remains a mystery (thank you MM editor Janet Walford).
Yet I also remember 1987 for another reason - it was the year when the Personal Equity Plan (PEP) was launched by Nigel Lawson, the then chancellor. A tax-free investment wrapper - a little too complicated to begin with - which paved the way for today’s Individual Savings Account.
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I was reminded of Lawson’s contribution to the cult of long-term savings earlier this month when he died at the grand old age of 91. Although most obituaries referred to his big part in transforming the UK economy in the late 1980s - through a mix of ambitious tax cuts and bold privatisation programmes - PEPs were a savings ground-breaker.
Without PEPs, we wouldn’t have seen John Major (as chancellor) launch Tax-Exempt Special Savings Accounts (TESSAs). And without PEPs and TESSAs, we wouldn’t have had Gordon Brown (again, as chancellor) bring them together to form ISAs.
I think ISAs are now the best investment thing since sliced bread. An investment fortress within whose walls you can build tax-free wealth, away from the prying hands of the taxman. No tax on savings interest earned within its four walls - and no dividend income tax or capital gains tax (CGT) on income or profits from holdings in shares, investment funds and investment trusts. Your own mini tax haven.
I spoke to former Tory minister John Lee a few days ago about Nigel Lawson - he now sits in the House of Lords as a Liberal Democrat. Lord Lee of Trafford, as he is now grandly called, was the country’s first ISA millionaire. He did this by investing (quite shrewdly) in PEPs right from the word go - and then continuing when ISAs came along. He maximised his contributions and reaped the rewards.
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He says investors should ‘give thanks’ to Lawson (Baron Lawson of Blaby) for his initial PEP creation and describes it as the ‘best tax-free investment wrapper in the Western world’.
It’s hard to argue against him. Compared to pensions, ISAs are a dream, a walk in the park. There are no crass rules governing how much your ISA is allowed to grow to before the taxman comes knocking on your door for a slice of the action. Yes the £1,073,100 cap on pension savings - the lifetime allowance - may have been temporarily lifted as a result of the March 2023 Budget, but it will be back with a vengeance if Labour wins the general election late next year.
Also, unlike a pension, there are no rules restricting how much you can put into a ISA as a result of the income you earn. It is as egalitarian as savings products come. Adults have a £20,000 annual allowance - April 6 to April 5 each year - and they can use as much (or as little) of the allowance as they can afford to. For children, the annual Junior ISA allowance stands at £9,000.
Of course, anything that costs the taxpayer money will inevitably attract the attention of those who work for the Treasury. So, it’s not unreasonable to think that Labour may look more closely at ISAs if they storm into power. Yet they may be content to continue with the policy that the current Conservative government has embarked on to shore up the nation’s finances - which is restrict the capital gains and dividend income that investors can receive outside ISAs before they are guillotined by tax.
Already, the annual capital gains tax allowance has been reduced from £12,300 to £6,000 - and from April 6 next year it will come down again to £3,000. Meanwhile, the annual tax-free dividend allowance has been cut in half to £1,000 and will be cut in half again next tax year to £500.
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What Labour might do as a coup de grace is increase the CGT rates on share sales from their current 10% (basic rate taxpayers) and 20% (higher and additional rate taxpayers) in line with income tax rates of 20, 40 and 45%.
Come what may, ISAs should be a vital part of your long-term financial strategy. I know times are tough, but use them if you can. Invest a little a lot if you can via a direct debit from your bank.
You might not join John Lee in the ISA millionaire club in the immediate future. But you will be laying down important financial foundations for the future.
Thank you Baron Lawson of Blaby for PEPs. Thank you Sir John Major for TESSAs. And thank you Gordon Brown for ISAs. Get ISA investing, dear readers.
Jeff Prestridge is Group Wealth & Personal Finance Editor, DMGT.
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