Money: Class war at the savings bank: how Labour is hammering the middle classes

The Government yesterday used the language of class warfare to launch a new tax-free Individual Savings Account which it claimed would benefit "the many and not just the few". The new account will replace existing PEPs and Tessas in April 1999. But Nic Cicutti argues that middle- class savers may be hit hard by the proposals.

Geoffrey Robinson, the Paymaster General, said the Individual Savings Account (ISA) would give everyone the opportunity to save for the long-term, by offering tax incentives previously available only to those able to invest large sums.

Mr Robinson said the ISA would have an annual savings limit of pounds 5,000, with an overall cap of pounds 50,000 on the total that can be placed in it.

This compares with a maximum of pounds 9,000 presently available to investors each year in Personal Equity Plans (PEPs), with no limit on the amount that can be tucked away. A further opportunity is on offer via tax-exempt savings accounts (Tessas) into which up to pounds 9,000 more can be placed over five years.

PEPs and Tessas will cost the Inland Revenue an estimated pounds 1.25bn in unpaid tax this year, rising to more than pounds 1.6bn by 2000. The Government's proposals will cap this amount to its present limits. Experts predicted that up to 750,000 people would be taxed for the first time on the slice of their savings above the ceiling placed on investments in the ISA.

Senior civil servants argued yesterday that while some 6.5 million people are thought to hold either a PEP, a Tessa, or both, those who invest in either scheme are more likely to be middle and upper-class savers. Lower income-earners have tended to be put off by minimum investment limits, often of pounds 30-pounds 50 a month, or the fact that they cannot obtain easy access to their money.

Mr Robinson said tax incentives, now available primarily to middle-class and high-income investors would be used to encourage everyone in society to set aside some money instead. "Saving for the future is both prudent and sensible, but over half the adult population of our country hardly save at all," he said. "I am determined that Britain should have a tax system for savings which benefits the many and not just the few. the new Individual Savings Account will suit any investor, no matter how large or small."

To facilitate the trickling-down of these tax benefits, Mr Robinson suggested that ISAs might be sold from a wider range of outlets than ever before: "Designed for easy access from banks, building societies and new outlets such as supermarkets, ISAs will enable people to put all forms of savings - cash, shares, life insurance and National Savings - in a tax-free `one- stop' account."

The Government's proposals involve investors being allowed to open a new ISA each year after April 1999. Both income paid from the account and gains on the investment will be free of tax. The pounds 50,000 cap will apply to the amount that can be placed in ISAs over the years. PEPs will cease to be sold after April 1999 and any amount held in them will have to be transferred into the ISA to enjoy the same tax-free benefits.

There will be a six-month period during which PEPs can be shifted into the ISA, up to the pounds 50,000 upper limit. Any PEP outside an ISA after 6 October 1999 will lose tax reliefs.

Tessas - cash deposit accounts typically sold by banks and building societies - have a fixed life of five years. The Government is proposing that they can remain outside the ISA net until maturity, after which they too will have to be transferred, again subject to the pounds 50,000 limit.

Some estimates suggest that out of the 6.5 million PEP and Tessa savers, up to 15 per cent - at least 750,000 people or more - currently have investments above pounds 50,000. They will start paying tax on the upper portion of their investments after April 1999.

Mr Robinson claimed yesterday that the change to ISAs would not disadvantage a growing army of mortgage borrowers, who have opted to pay off their interest-only loans with tax-free PEPs.

A senior Inland Revenue official argued that lenders which were consulted had said none of their borrowers with a PEP mortgage would breach the pounds 50,000 ISA transfer limit.

However, John Whiting, a tax partner at Price Waterhouse, added: "The reality is that those with a million, or pounds 10m, will always find tax-advantageous places to invest their money. For them pounds 5,000 or pounds 6,000 a year is peanuts. But there are many people, comfortably off, for whom this will be a blow."

the key questions

What is the Individual

Savings Account?

The account, to be known as the ISA, is the new tax-free savings alternative to personal equity plans (PEPs) and tax-exempt savings accounts (Tessas). It will come into force in April 1999.

What will be the ISA's

tax benefits?

Investors will be able to save up to pounds 5,000 a year in an ISA, up to a total of pounds 50,000 in all. Income from the ISA and growth in the value of investments will be free of tax.

Is the ISA all about

equity investments?

No. You will be able to place up to pounds 1,000 a year into a cash-based account. There will be no loss of tax benefits if you withdraw some or all of the money.

How does the ISA compare with PEPs and Tessas, which are also tax-free?

With PEPs, you could place up to pounds 9,000 a year into single company or pooled investments. Tessas allowed you to invest up to pounds 9,000 over five years.

Will I be able to transfer my PEPs and Tessa into the ISA?

Yes. But it will be subject to the pounds 50,000 upper limit on ISAs. Thereafter, you will only be allowed to invest to that limit.

Why didn't the Government simply leave PEPs and Tessas in place?

More than 6.5 million people have put up to pounds 70bn into PEPs and Tessas. These investments have mostly benefited those who can already afford to save. However, the main reason is that the Inland Revenue was fed up with losing spiralling amounts of tax from PEPs and Tessas. It will now be able to cap these "losses" at about pounds 1.5bn a year.

Who will lose out?

The ultra-rich will lose one minor tax haven. But the biggest losers will be middle-class savers with pounds 50,000 or more to set aside, a large but not inordinate sum.

Will ISAs encourage poorer people to save? And will they benefit from it?

Put it this way: if you saved pounds 30 a month, the typical tax benefit from a high interest ISA paying 6 per cent net would come to an extra pounds 4.32 a year. As for encouraging you: if you had no money anyway, how much would you be setting aside?