The Treasury Committee has urged the chancellor not to cut the Cash ISA allowance in next month’s Budget, warning it would do little to boost retail investing. AJ Bell says simplifying ISAs, such as combining Cash and Stocks and Shares ISAs into one, would better encourage savers to move from short-term saving to long-term investing.
Tom Selby, director of public policy at AJ Bell, comments:
“While the chancellor’s policy goal of boosting retail investing in the UK is the right one, slashing the Cash ISA allowance would be a clumsy and ineffective way to go about it. All this would do is hardwire the barriers that currently exist between Cash ISAs and Stocks and Shares ISAs, when behavioural research tells us tearing these barriers down and simplifying the landscape would be the most effective way of helping more people invest for their financial future.
“Cutting the Cash ISA allowance could also lead to a scarcity mindset around Cash ISAs, resulting in a ‘use it or lose it’ approach towards contributions under a lower annual limit. What’s more, the inevitable ban on transfers from Stocks and Shares ISAs to Cash ISAs would create friction in the system and potentially mean those considering a Stocks and Shares ISA worry about being locked in to the account.
“Rather than tinkering with allowances or reheating the unnecessary and ill-thought-out UK ISA, the chancellor should focus squarely on the needs of retail investors by addressing the negative impact the siloed ISA structure has, where people all-too-often simply stick with cash saving when they could be better off investing. Given ISA investors exhibit a significant ‘home bias’ towards the UK, boosting retail investing through simplification should also naturally benefit UK capital markets.
“The obvious starting point for this consumer-focused reform would be to combine Cash ISAs and Stocks and Shares ISAs, the two most popular versions of ISAs in the UK, into a single main ISA product. As well as simplifying the overarching ISA framework, this reform would make it easier for people to transition from holding cash to investing for the long term and support wider efforts to boost retail investing, improve financial resilience and drive economic growth.”
How the siloed ISA structure entrenches a resistance to investing
AJ Bell recently supported a report carried out by behavioural economists, Drs Richard Whittle and Stuart Mills, that explores the UK’s ISA system and behavioural barriers blocking growth in retail investing.
The report concludes the design of the ISA system creates friction and complexity, deterring longer-term investments and presenting the Cash ISA as the ‘easy’ choice, and recommends moving away from a siloed structure in the ISA market, alongside measures to steer consumers toward good long-term ISA outcomes through improved financial guidance.
Details of the review
A review of the UK’s ISA savings and investment landscape from behavioural economics researchers, supported by AJ Bell, has identified multiple behavioural and structural barriers which exacerbate the tendency to hold cash savings rather than investments.
The review considers a range of behavioural factors which discourage people from investing for the long term and examines how these interact with the design of the UK’s ISA system. It concludes that ‘a complex and siloed structure exacerbates savers’ tendency to short-term cash holdings’, and that simplifying ISA choices and eliminating the binary distinction between cash and investments could remove structural barriers to long-term investing.
The paper, submitted to HM Treasury officials, will inform AJ Bell’s continued engagement with policymakers over future ISA reforms, with the business having long campaigned for simplification of the ISA system. Government has indicated it will reform ISAs to ‘get the balance right between cash and equities’ and ‘boost the culture of retail investment’.
The following is a summary of the research.
Summary
The UK’s Individual Savings Account (ISA) system – a fundamental of UK saving policy – has become fragmented into multiple products. Each with its own rules and purpose, but all subject to an overall ISA allowance. These multiple different products become silos, creating separate accounts for different goals and different products requiring separate decisions and processes.
The complexity of the ISA system exacerbates savers’ biases toward short-term savings. Only around 15% of UK adults hold a Stocks and Shares ISA, compared to around a third of UK savers holding a Cash ISA. Indeed, a portion of savers are reported as using Cash ISAs for long-term retirement savings when better products are available.
Several factors contribute to this short-term cash savings bias. Firstly, behavioural barriers make individuals more likely to prefer ‘safe’ cash savings. The real risk of inflation to the value of cash savings is rarely considered. Secondly, the design of the ISA system creates friction and complexity, deterring longer-term investments and presenting the Cash ISA as the ‘easy’ choice.
Behavioural barriers to longer-term investing
- Inertia and status quo bias: Once money is sitting in a Cash ISA doing nothing is often the easiest thing. People tend to stick to the status quo by default. Around 70% of individuals with more than £5,000 in cash savings have never even considered investing in a Stocks and Shares ISA.
- Loss and risk aversion: People generally dislike losses more than they like equivalent gains. This loss aversion makes the potential downsides of investing loom larger than the upsides.
- Present bias and liquidity preference: Savers may give disproportionate weight to immediate needs and access to their money, over long-term growth. Cash ISAs are seen as liquid and readily accessible providing comfort that funds can be accessed at any time. In contrast Stocks and Shares ISAs are often perceived as illiquid.
- Mental accounting and categorisation: People mentally separate their savings. Once money is in a Cash ISA it tends to stay there. First choices are often sticky, and switching to a Stocks and Shares ISA is an additional step.
Structural barriers
The ISA system’s design itself creates barriers to long-term saving.
- Complex product choices: There are several ISA variants, each with different limits and rules. Deciding how to allocate money across products can be a further friction in the decision process.
- Separate accounts and transfer friction: Each ISA is a fully separate product; one needs to set up separate accounts if they wish to hold both cash and investments. This administrative process may be a powerful barrier to longer-term investing behaviours.
Recommendations
Reform of the ISA system is required. Presently its complex and siloed structure exacerbates savers’ tendency toward short-term cash holdings. Simplifying ISA choice, eliminating the separation between cash and investments, will remove the structural barriers to long-term saving.
Alone this is unlikely to combat the existing behavioural barriers to investment saving, however incorporating informative design principles into the development of any new (combined) ISA product can help steer customers toward good saving behaviours and outcomes.
About the report
This report was authored by Dr Richard Whittle and Dr Stuart Mills in partnership with AJ Bell, a leading provider of investment platforms and services in the UK. It examines the behavioural and structural barriers influencing how individuals in the UK use Individual Savings Accounts (ISAs), with a particular focus on why many savers continue to default to cash products rather than long-term investments.
Dr Whittle and Dr Mills draw extensively from behavioural economics and financial decision-making research to provide insights into the psychological biases, such as inertia, loss aversion, and mental accounting, that shape savings behaviours. The report also identifies key structural frictions within the ISA framework that reinforce these behaviours, presenting a compelling case for policy reform.
