During the early stages of the pandemic, American households managed to save nearly $2.1 trillion, providing a buffer against record inflation and economic uncertainty. However, this ‘excess savings’ has now dissipated, highlighting the need for public policy to encourage greater savings. The complex system of incentives currently in place calls for reforms to ensure tax policy does not hinder household savings.
Fortunately, Americans can look to Canada and the United Kingdom (UK) for inspiration. The UK, in particular, has a strong track record of providing households with a broad, simple vehicle for savings—the Individual Savings Account (ISA).
ISAs began as Personal Equity Plans (PEPs) in 1986, intended to broaden investment opportunities for UK savers. In 1999, PEPs were replaced by ISAs, and the maximum annual contribution has since increased to £20,000 (about $25,000) annually. ISAs supplement the UK’s retirement savings system, which includes pensions similar to U.S. traditional 401(k) plans.
Like Tax-Free Savings Accounts (TFSAs) in Canada, the UK’s ISAs are Roth-style tax-advantaged savings accounts. Contributions are made with after-tax dollars, and earnings grow tax-free. There are no taxes, penalties, or restrictions on withdrawals, making ISAs a simple way for households to save for various future financial goals. Unlike Roth Individual Retirement Accounts (IRAs) in the U.S., there are no income limits for ISA eligibility.
ISAs have grown in popularity over time. In 1999, about £28.4 billion were invested in ISAs across 9.3 million people. By 2021, nearly £67 billion was invested across 11.8 million people within adult ISAs. More than 22 million people in the U.K. hold some type of ISA—equating to roughly 40 percent of the eligible adult population representing households across the income spectrum.
ISAs are popular in the UK because they are a simple, liquid savings option for households, functioning like a regular savings or investment account but without any tax on the returns and no restrictions on the use of funds. This is attractive and useful to millions of UK households at different income levels, life stages, and with different financial goals.
For U.S. policymakers looking to encourage greater saving and financial security, particularly among low- and moderate-income households facing serious affordability challenges, the experiences in both the UK and Canada indicate that universal savings accounts are an effective policy tool to help reach that goal.
Source: Tax Foundation