ISA dilemma···If benefits are reduced, investors push back; if expanded, the ‘Korea market’ is ignored - 경향신문

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On the 10th, when the KOSPI opened higher, a display board in the dealing room of Hana Bank in Jung-gu, Seoul shows the KOSPI and KOSDAQ indices. Yonhap News

In the government's recent tax reform package, the individual savings account (ISA), dubbed the ‘people tax-saving account’, has become a hot-button issue. This is because the ‘unlimited’ maturity extension and the carry-forward of the annual limit that the government announced in 2020 as ISA benefits have disappeared six years later.

The government also offered a ‘carrot’ by tripling the total ISA investment cap to 300 million KRW, but investor reaction has been cool. Investors who make long-term investments in overseas equity products via ISAs have pushed back hard, calling it a ‘policy that kicks away the ladder’, and President Lee Jae Myung recently ordered a full review of the ISA system.

However, as ISAs have effectively morphed into an ‘overseas investment tax-saving account’ due to the repeal of the financial investment income tax, there are concerns that if benefits for the general ISA are expanded, the tilt toward overseas investment may continue, contrary to the government's intent.

Under the currently announced ISA improvements, a new productive ISA that invests only in domestic assets will be created, with all investment gains tax-exempt, and the youth type will offer an income deduction of 10% of contributions. This provides more favorable taxation than the general ISA, which applies a low, separate 9.9% tax to amounts exceeding the tax-exempt cap on investment gains.

In particular, the government presented a carrot by allowing concurrent enrollment in the productive ISA and the general ISA, doubling the annual contribution limit eligible for tax savings to 40 million KRW and tripling the total cap to 300 million KRW (100 million for the general type, 200 million for the productive type).

The caps are now higher than Japan’s ‘NISA’, which allows 3.6 million yen per year (about 32.2 million KRW) and 18 million yen in total (about 160.95 million KRW).

Instead, a ‘stick’ was applied to the general ISA. While setting the contribution period for the productive ISA at up to 10 years (3 mandatory years + 7 years of extensions), the government reduced the contribution period for the general ISAwhich had allowed ‘unlimited maturity extensions’to a maximum of 5 years (3 mandatory years + 2 years of extensions).

Previously, indefinite tax deferral and offsetting of gains and losses were possible, but under the revisions, the account must be closed every five years, gains and losses settled, and taxes paid. For investors who believed in long-term growth and dividend growth and reinvested tax savings to benefit from compounding, the advantages would be greatly diminished.

Why is the government lowering benefits for the general ISA?

The ISA, introduced to support asset building by middle- and lower-income groups, prohibits enrollment and extensions by comprehensive financial income taxpayers whose annual interest and dividend income exceeds 20 million KRW. However, there was a limitation whereby, if the maturity was set long, even if one became a comprehensive financial income taxpayer during the subscription period, the existing tax-saving benefits were maintained. The purpose of lowering benefits for the general ISA was to screen out high-income earners who do not fit the ISA's target and to levy taxes.

A Ministry of Economy and Finance official said, “The intent of the general type is low-rate separate taxation, so it does not match the legislative purpose if taxation keeps not applying,” adding, “If the maturity is set long from the outset, there is the problem that one cannot check whether the person is a comprehensive financial income taxpayer.” Lee Sang-min, a research fellow at the Nara Salim Research Institute, also said, “Indefinite tax deferral cannot be considered normal, so settling taxes (by limiting the maturity) is a common-sense measure.”

Fundamentally, the government's concern is rooted in the fact that the ISA has effectively turned into an ‘overseas investment tax-saving account’.

From the outset, the current ISA was bundled with the financial investment income tax in the 2020 tax reform plan, and reform of the system was pursued together. At that time, the contribution period was expanded to the current standard, and the following year’s tax reform confirmed full exemption of capital gains on domestic stocks and domestic stock index exchange-traded funds (ETFs) within ISAs. Since the introduction of the financial investment income tax would have taxed capital gains on domestic stocks above 50 million KRW, the idea was to increase ISA benefits to encourage stock market investment through tax savings.

However, the repeal of that tax rendered the expanded benefits moot. As capital gains on domestic stocks became tax-exempt, the advantage of ‘Korea market investing’ via ISAs disappeared, and conversely the tax-saving effect of overseas equity ETFs came to the fore.

In fact, the share of overseas investment ETFs within brokerage-type ISAs has been steadily growing. The share was just 4% (valuation 167.3 billion KRW) at end-2021, when brokerage-type ISAs were first introduced, but it rose to 31.7% (5.6505 trillion KRW) by end-2024 as the ‘US market investing’ boom took off in earnest. In November last year, when overseas stock investing surged and the exchange rate moved in the opposite direction, the share climbed to 33.5%, surpassing domestc stocks (33.4%) to rank first within ISA holdings. The valuation of overseas ETFs also reached 23.8007 trillion KRW as of end-June, nearly doubling in half a year.

This reflects the fact that the ‘standard play’ has become using ISAs for long-term investment in U.S. index-tracking and dividend products dubbed the ‘Korean versions of SPY and SCHD’, while using regular accounts for domestic stocks. From the government's perspective of trying to channel investment into domestic assets, it needs to curb the ISA tilt toward overseas investment, but with capital gains on domestic stocks already tax-exempt due to the tax repeal, there are few cards to play.

A specialist who participated in designing the financial investment income tax said, “There have long been critiques of granting tax-saving effects to overseas investment, as the ISA can encourage overseas stock investing where capital gains taxes apply,” adding, “With the tax not in force, additional tax benefits would have limited impact, so there was likely no clear incentive other than shortening the (general ISA) maturity.”

As investors who mainly invest in overseas ETFs pushed back strongly, President Lee Jae Myung was reportedly critical of the recent ISA reform plan, saying, “Why was it done that way without proper preparation?”, and ordered a full review. The move reflects sensitivity to investor sentiment.

However, there are concerns that if benefits for overseas investment are restored, the advantages of the productive ISA, which favors domestic products, could be further diminished. Without differentiated contribution periods, it is hard to feel the dividend tax exemption effect of the productive ISA except for certain domestic covered-call ETFs and ELS. For young people with little taxable income to deduct, the income deduction of the youth ISA offers limited or no benefit.

An industry source in financial investment said, “Given dividend yields are far lower than in the United States, no one invests in the Korea market just to ‘collect dividends’, so it is doubtful whether restoring the system would create an incentive to invest in the Korea market.”