The new Individual Savings Account - What it is and how it will affect the savings market

The government has recently announced the final form of the Individual Savings Account ("ISA"), which will bring major changes to the savings industry. The ISA will begin on 6 April 1999 and the government has guaranteed the continued existence of the ISA as a savings vehicle for at least 10 years. The scheme will be subject to review after 7 years to decide on any changes to be made after the 10 year period.

What do we know about the ISA?

The account is a tax-advantageous "umbrella" under which can be placed four different sorts of investment:

• Cash (including National Savings) (up to £1000 per annum);
• Life insurance (up to £1000 per annum); and
• Stocks, shares, unit trusts (up to the £5,000 annual maximum and with no minimum UK equities holding).

Individual investors, along with the account managers, decide the exact makeup of each account within an overall limit of £5,000 per annum, although in the first year of the scheme (1999/2000) the annual limit will be £7,000, of which no more than £3,000 can go into cash and £1,000 into life assurance. The government has dropped the controversial £50,000 lifetime upper limit under great pressure form the financial services industry.

Any investments within these limits are exempt from tax. In addition a 10% tax credit will be paid for the first 5 years of the scheme on dividends from UK equities. This will apply to equities in the stocks and shares component of the ISA, and to equities which back policies in the life assurance component.

There will be no statutory "lock-in" period for an ISA. However, individual account managers may agree with their customers to restrict access, and we therefore expect this to be one area where the level of competition in the market place will determine the eventual form which the ISAs will take. Withdrawals from an ISA will be without tax penalty.

Investors who already have a PEP will be able to transfer their entire balance into an ISA. In relation to TESSA's the capital (but not the accumulated interest) may be transferred into the cash component of the ISA when the TESSA matures.

Subscriptions to PEPs can be made up until 5th April 1999, and any PEPs held at that date can continue as PEPs with the same tax advantages as before or be transferred into an ISA.

TESSAs can continue to be opened until 5th April 1999 and run for a further 5 years from that date. Annual subscriptions to a TESSA will not affect the annual ISA subscription limit.

What don't we know about the ISA?

It is not yet clear who will be allowed to provide ISAs. As part of its intention to ensure that ISAs are available to the vast majority of savers, the Government has suggested that the product could be organised by mass retailers such as supermarkets in order to make it more accessible, and that they might be encouraged to apply for a "kitemark" to show that they have reached certain minimum standards.

It is not yet clear whether or not product providers will be able to charge customers for the £1 billion (estimated) cost of the transition from TESSAs and PEPs to ISAs.

It is also not clear how the ISA will be regulated. If regulation is tight, for example as tight as the regulation currently in place for sales of life assurance (one of the ISA's four possible elements) this will raise costs and discourage mass retailers from joining in, disenfranchising the low income savers which the product is aimed at. It would also mean that investors in the low-risk elements of an ISA's would be subsidising the costs incurred by those purchasing the more risky, and therefore more highly regulated, elements. However, if regulation is more relaxed, for example as relaxed as that which governs the sale of national savings products (another of the ISA's four possible elements) then this may lead to fears that the life assurance element will be missold to those who cannot afford to save.

The Government has not made it clear which life insurance policies will be covered by the ISA. The Inland Revenue have said that only "true life assurance policies" will be allowed under the ISA umbrella, but the extent to which this includes combined products such as savings/health insurance is unclear.

When shares are received from the demutualisation of a building society the shares will not be able to be transferred into an ISA. Shares issued in connection with an approved profit-sharing scheme or savings related share option scheme will be allowed to be transferred straight into an ISA at market value. The value transferred will count towards the annual subscription but no Capital Gains Tax liability will arise on the transfer.

What should you be doing to prepare for the introduction of the ISA?

PEP and TESSA providers should consider writing to investors to explain that, following the budget, that they do not think that the new ISA will unduly affect the majority of savers, who do not need to do anything at this stage with regard to the possible transfer of funds between PEPs/TESSAs and ISAs. This should inform and reassure them, and also allow those companies planning to offer ISAs to begin to market them to their existing savings customers.

Those intending to offer ISAs should begin to plan the way in which they will be marketed. For example, the government is keen to introduce mass-retailing techniques to ensure that the number of people saving doubles, from 6 million to 12 million. This is likely to make the ISA a low-margin product, and providers might consider linking up with a company with a large marketing base, such as a supermarket or garage chain.

Providers of PEPs and TESSAs should begin to consider how their systems might need to be adapted to cope with transfers to the ISA, as the implementation date is only a year away.