It’s only just reached its 20th birthday, yet the darling of the savings world is looking decidedly washed up.
Isas were introduced in 1999, replacing tax-exempt special savings accounts (Tessas) and personal equity plans (Peps). The original cash Isa allowance stood at £3,000, but you can now save up to £20,000 each year. The cash Isa’s tax-free status meant it became a firm favourite among savers, with subscriptions peaking at 12.2 million in 2008-09.
But it’s since lost its sparkle. The latest data from HMRC reveals that just 7.8m accounts were opened during the 2017-18 tax year – a drop of nearly 700,000 compared to 2016-17. This marks the second year in a row that cash Isa subscriptions have fallen dramatically.
So what’s prompted savers’ change of heart? It’s no coincidence that the first marked drop-off in subscriptions was seen in the 2016-17 tax year – that’s when a change in tax rules put ordinary savings accounts on level pegging with cash Isas.
Before April 2016, a cash Isa was the only way to protect your savings from tax, but a basic-rate taxpayer can now earn up to £1,000 in interest each year without paying a penny to HMRC, while higher-rate taxpayers can earn £500, regardless of what type of account you hold your savings in.
According to the government, these rules – known as the personal savings allowance – mean that 95 per cent of savers don’t have any tax to pay on their nest eggs, wiping out the unique selling point of an Isa in the process.
Now that most people don’t have to worry about tax on savings, it’s much easier to compare Isas and ordinary savings accounts – just look for the highest headline rate of interest. And when you do, you’ll see that Isas are often lagging behind.
Savers today can only dream of the kind of returns on offer when Isas launched 1999 – the most generous accounts back then paid a rate of 6.5 per cent. Historically, cash Isa rates easily outstripped those on ordinary savings accounts.
If, in January 2007, you had put £3,000 – the full allowance at the time – into an instant-access Isa paying the average rate (4.83 per cent), you would have earned £145 after a year. The same in an ordinary savings account would have returned just £80 for basic-rate taxpayers or £60 for higher-rate taxpayers.
Today, the difference between the market-leading instant-access Isa and instant-access savings account (based on a £3,000 deposit) would be less than £1 after a year – and that’s in favour of the savings account, with the Marcus account from Goldman Sachs paying 1.5 per cent, compared with Skipton Building Society’s Online Bonus Isa, which pays 1.48 per cent. It’s a sorry reflection on the state of the savings market that this instant-access account paying 1.5 per cent was such a talking point when it launched a few months ago.
Back in 2013, I was lamenting the fact that the best instant-access rate had fallen from 3.2 per cent to 2.1 per cent in the wake of the Funding for Lending Scheme, which was introduced in August 2012 with the aim of providing cheap finance to banks to fund mortgage lending. The knock-on effect was that banks began merrily cutting savings rates because they were no longer as reliant on customer deposits.
Six years on, it’s clear that this was just the beginning of a long and bumpy ride for savers. Today, you’ll have to be prepared to tie up your money for at least a year in a fixed-term account to stand a chance of matching the 2.1 per cent return that was available on an instant-access account in 2013.
So if you come across firms offering bonds paying more than double this, take care. The recent collapse of London Capital and Finance (LCF) is a shocking cautionary tale.
Over the past few years we heard from many interested savers who had seen their adverts for eye-catching rates of up to 8 per cent – in some cases LCF’s products were listed alongside ordinary cash savings accounts on online comparison tables.
But these products – known as mini-bonds – are in fact high-risk investments; essentially a loan to a company in return for regular interest payments. In December 2018, the FCA ordered LCF to withdraw its promotional material because of concerns that customers may not have been clear about the nature of the products they were putting their money into.
Unlike savings bonds, mini-bonds are not covered by the Financial Services Compensation Scheme (FSCS), which can protect you when financial firms fail. As a result, the 11,000 people who put their savings into LCF have been left out of pocket by £236m, with little hope of compensation.
Shortly after the FCA announced last month that there would be an independent review into LCF and the regulator’s handling of the firm, it issued a warning about innovative finance Isas, which it says are being promoted alongside cash Isas.
Innovative Finance Isas allow you to use your tax-free Isa allowance to invest in peer-to-peer loans, but unlike cash Isas you may not be protected by the FSCS if a firm were to collapse.
While the Isa has seen plenty of upheaval in its two decades, it remains a trusted name. But as the range of products that carry this label grows, and as savers increasingly look beyond cash to find a meaningful return, it seems more action is needed to tighten up marketing and stop lines being blurred between products that might appear similar but operate in very different ways.
It’s unacceptable that savers could be punished for taking risks they weren’t even aware of.
Jenny Ross is the Which? Money editor