Who wins and who loses from Isa changes?

Labour's new rules for saving schemes, are another blow for some savers, says Annie Shaw

Savers are set to protest about the withdrawal of tax credits on Isa dividends from next month by voting with their feet.

Savers are set to protest about the withdrawal of tax credits on Isa dividends from next month by voting with their feet.

Research conducted by YouGov reveals that once the tax credit on dividends paid out by shares held in an equity Isa is withdrawn from next month almost half of all equity Isa investors will be less likely to invest in Isas. One in eight Isa investors say they will probably not invest any more at all.

The tax credit was originally a rebate of Advance Corporation Tax that companies paid on their distributions. It stood at 20 per cent until April 1999, when Gordon Brown cut it to 10 per cent. For basic-rate taxpayers, there was no additional tax liability. However, for higher-rate taxpayers the tax credit could still be set off against any further liability, leaving them with just another 22.5 per cent to pay on the gross dividend.

After the change to the rules in 1999, individual non-taxpayers were no longer able to reclaim tax credits on their dividends, but until next month anyone holding their investments in a tax-free Pep or Isa wrapper still could. The change from next month brings the holders of Peps and Isas into line with other shareholders.

The removal of Isa tax credits is the latest blow to savers from the Labour Government, which during its time in office has presided over the savings ratio plummeting by nearly half. According to figures from the state-run National Statistics, since Labour came to power in 1997, the level of personal savings has dropped by 5.9 per cent from 10 per cent.

Mike Webb, head of distribution at Invesco Perpetual, which commissioned the survey, says: "Our research shows that by taking away the 10 per cent tax credit, the Government will be responsible for yet more investors turning away from Isas - a vehicle set up by Labour to encourage people to save."

More than a third of investors say they will not bother to save when the total amount that can be invested in an Isa drops from £7,000 to £5,000 in April next year, a move which is described as "confusing" to investors.

Jason Hollands of Isis Asset Management says: "When it comes to language, both Government and the financial services industry agree that the public needs to save more, but words need to be matched with actions. We urge the Government to send a positive signal that Isas continue to be a key element of their savings strategy."

The appeal is echoed by the Pep and Isa Managers Association (Pima), which has joined forces with the Association of Investment Trust Companies, the Association of Private Client Investment Managers and Stockbrokers, the Building Societies Association, the Association of Independent Financial Advisers and ProShare. This pressure group will lobby the Government to encourage more saving among the public, and has drawn up a five-point plan regarding the future of Isas, which includes the retention of tax breaks.

Tony Vine-Lott, Pima's director general, says: "Isas have proved the most popular savings vehicle this Government has introduced, and now form a key part of day-to-day and retirement saving for millions of people. To ensure the continued success of the Isa scheme we urge the Chancellor to drop his plans to abolish the Isa dividend tax credit and the reduction in Isa subscription limits."

However, despite some of the tax breaks being lost in the new moves, there are still advantages to investing in an Isa. Invesco Perpetual's Mark Dickson, head of product development, says: "Only those in income Isas will be affected by the dividend tax credit change. Isas still offer worthwhile shelter from income tax and CGT gains. Tax relief on dividend income in Isas was an anomaly: it has already been removed elsewhere, so removing it on equities held within an Isa did not come as a surprise.

"You are still going to be better off in an Isa, even in the worst case. Most Isa providers make no additional charge for holding funds in an Isa."

Higher-rate taxpayers will still benefit most from maintaining their Isas, despite the fall in income. An investor who used to get dividend income of £100 will still collect £90 compared with the £67.50 he would get without the benefit of an Isa wrapper. A basic-rate taxpayer now also gets £90 - the same as if he did not have an ISA - but the investment benefits from being sheltered from capital gains tax.

'Cutting back sends out the wrong message'

Louise Dixon, 38, of Halifax in West Yorkshire, has two Invesco Perpetual Isa funds: the High Income fund and the European Equity fund.

Ms Dixon, a product development director at a textile company, feels that while there are ongoing pensions issues, university tuition fees to save for and rising house prices, investors should be given more incentives to save, not have their incentives taken away.

"While I can rarely save enough to take up the maximum allowance," Ms Dixon says, "I think that cutting it back is sending the wrong message out."

Ms Dixon will, however, keep investing in her Isas as she feels this is the most tax-efficient and convenient way for her to save.