At the center of Japanese Prime Minister Fumio Kishida's asset-income doubling plan, is a significant enhancement to the NISA from January 2024. Haruka Urata, Chief Researcher at Fidelity Institute, analyses the changes to the NISA scheme and the potential impact on asset building behavior of investors in Japan.
1. What is NISA?
NISA is a system that exempts dividends earned from investing in stocks and mutual funds, as well as gains from selling stocks that have risen in value, from income taxes that would otherwise be levied. It was originally modeled after the U.K. ISA (Individual Savings Account) and was named NISA to mean the Japanese version of an ISA (N stands for Nippon = Japan). The NISA was first introduced in 2014, and then the Tsumitate NISA, another type of NISA, followed in 2018.
Historically, dividends and gains from the sale of stocks and mutual funds were taxed at 20% in Japan. However, after the bursting of the bubble economy, the tax rate was reduced to 10% in 2004 in an effort to stimulate the long-depressed Japanese stock market. When the tax rate was returned to its original level of 20% in 2014, the NISA was introduced as a temporary measure to mitigate the impact of such a drastic change*¹.
*¹ To be precise, the current tax rate is 20.315%.
Given the background to its birth, the NISA was destined to disappear at some point in the future. However, there have been persistent calls since its introduction for the system to be made permanent. Prime Minister Kishida has decided to make the system permanent through the new NISA, which is central to his asset-income doubling plan designed to encourage Japanese people to shift their money from cash and bank deposits into investments, under the slogan “savings to investment”.
The new NISA will operate as a separate scheme from the current NISA, and money invested in a current NISA will not be converted into the new NISA. This is because the Japanese government wanted to complete the system development required to support operations of the new NISA as soon as possible in time for the launch in January 2024.
2. The current NISA
Before discussing the new NISA, let’s review the current NISA. There are two types of current NISA*². One is the General NISA, which allows you to invest up to 1.2 million yen a year and has a tax-free period of 5 years, and the other is the Tsumitate NISA, which allows you to invest up to 400,000 yen a year but has a tax-free period of 20 years. You can't enroll in both at the same time, and so you have to choose one or the other. As the name "Tsumitate" suggests, the Tsumitate NISA requires you to make an investment at least twice a year. It depends on your financial institution, but usually you are expected to make monthly contributions into your investment savings account.
*² There is another type of NISA, called a "Junior NISA," for those aged under 18, but I won't go into that because it is immaterial and will be abolished in 2023.
Chart 1 shows the growth in the number of NISA accounts since 2018. You can see in Chart 2 that the General NISA is more popular among older generations, while the Tsumitate NISA appeals to younger generations.
You can invest in listed stocks, mutual funds (investment trusts), ETFs, and REITs in a General NISA. However, you are only allowed to invest in mutual funds and ETFs that the FSA (Financial Services Agency in Japan) has pre-selected in a Tsumitate NISA.
Chart 3 shows a proportion of aggregated cash inflows into listed stocks, mutual funds, ETFs, and REITs in General NISAs. Most money goes into listed stocks and mutual funds, and much less goes into ETFs and REITs.
JPY billion Source: Financial Services Agency
The Tsumitate NISA is designed for unsophisticated investors. The FSA carefully excludes products that may be volatile, complex, or expensive from its qualifying investment options to protect new investors. As at February 9, 2023, 188 index funds, 26 actively managed funds, and 7 ETFs are approved as qualifying investment funds by the FSA. Index funds are by far the most popular choice of investment in a Tsumitate NISA. 86.3% of cash inflows go into index funds, while only 9.0% into actively managed funds as of September 2022. See Appendix for more detailed data.
3. Comparison between the current and new NISA
Let’s now see the features of the new NISA by comparing it with the current NISA. A summary comparison table is presented below in Chart 4.
Chart 4: Summary of the Current NISA and the New NISA
4. Annual investment contribution limits
In the new NISA the annual investment contribution limits or allowances have increased substantially. The General NISA will be renamed to "Growth Quota" and the annual contribution limit will be doubled from 1.2 million yen to 2.4 million yen. The "Tsumitate Quota", which is the successor to the Tsumitate NISA, will be 3 times larger at 1.2 million yen from 400,000 yen.
Furthermore, under the new NISA system, both the Growth Quota and the Tsumitate Quota can be used simultaneously. Therefore, the effective annual contribution limit will be 3.6 million yen, which is the sum of both. This is an unprecedented, major revision in the history of Japan's tax incentive system. As the Growth Quota allows you to buy individual stocks, you will now be able to buy more expensive stocks in the new NISA.
2.4 million or 3.6 million yen a year means 200,000 or 300,000 yen a month. These round numbers are easy for consumers to remember. Being “Easy to understand” is key for financial schemes to have mass appeal. The new NISA has been designed with this in mind.
It is widely anticipated in Japan that the new NISA will appeal to the general public. Many individuals with no investment experience will start investing, thanks to the new NISA. The number of Japanese “investors” will definitely increase. With an annual investment allowance 2 -3 times higher, there should be more money flowing into the stock market. “Savings to investment” is certainly going to happen.
5. Elimination of the tax-free period
Under the current scheme, the tax-free period is set to five years for the General NISA and 20 years for the Tsumitate NISA. These limited tax-free periods disappear in the new NISA, and you will be able to enjoy tax benefits indefinitely.
It has been acknowledged that particularly in the case of the General NISA, the short tax-free periods can induce short-term buying and selling as investors are prompted to sell as soon as the price of their investments increases. Let’s see how it works in Chart 5.
Chart 5: General NISA Induces Short-term Trading
Suppose you buy Stock A for 1 million yen. As stock prices fluctuate all the time, unrealized gains (when the price is higher than the purchase price) and unrealized losses (when it is lower than the purchase price) occur over a period of 5 years. Let's say that after 5 years of the tax-free period, the price of Stock A happens to be 200,000 yen (unrealized loss). Then, Stock A is transferred to a non-NISA brokerage account with no tax benefit as if it had been purchased for 200,000 yen. Suppose you sell Stock A for 650,000 yen, because the stock was originally purchased for 1 million yen, you lose 350,000 yen (1 million yen - 650,000 yen) on the sale. Therefore, you should not have to pay taxes. However, when calculating income tax, you are taxed on 450,000 yen profit because you were regarded as having sold Stock A for 650,000 yen, as it was bought for 200,000 yen.
In order to avoid this situation, the investor should sell during the tax-free period while the price is above the original purchase price. The investor won't be taxed during that period because of the tax benefits of the NISA. In other words, if you have unrealized gains, it's better to sell them within those five years. As a result, the investor ends up buying and selling in a short time period. Long-term investment is the recommended approach to asset building, but the reality is that the General NISA encourages actions against this.
Under the new NISA, the tax-free period is indefinite. The above issues will be eliminated. This represents a significant change that will lead savers to the basics of asset building.
6. Introduction of lifetime limits
Last but not least is the introduction of a lifetime allowance. Under the current General NISA, 6 million yen (= the annual investment limit of 1.2 million yen, times the tax-free holding period of 5 years) is the maximum you can invest. In the Tsumitate NISA, it is 8 million yen (= the annual investment limit of 400,000 yen, times the tax-free holding period of 20 years).
Under the new NISA, a lifetime investment allowance of 18 million yen will become available. There is a lifetime contribution limit that applies only to the Growth Quota, which is 12 million yen. It is a little confusing, but if you invest only in the Tsumitate Quota, you can still invest up to 18 million yen. If you use the Growth Quota, you can use up to 12 million yen in a Growth Quota, plus up to 6 million yen in a Tsumitate Quota, for a total lifetime investment allowance of 18 million yen. Of course, you can use a combination of, for example, 10 million yen in a Growth Quota plus 8 million yen in a Tsumitate Quota, or 5 million yen in a Growth Quota, plus 13 million yen in a Tsumitate Quota. These combinations are illustrated in Chart 6.
Chart 6: Illustration of Lifetime Investment Limits
Note that the calculation of the lifetime allowances of 12 million yen and 18 million yen is based on a book-value basis, and the price appreciation is not included in the calculation.
In other countries that have a lifetime allowance system in financial savings schemes, an inflation-link is occasionally found. This is because inflation reduces the real value of money over time. Therefore, the lifetime allowance should be increased in order to keep up with rising prices. The lifetime contribution limit in the new NISA in Japan is not currently linked to inflation. It is possible that this may need to be reconsidered in the future, if inflation is no longer negligible in Japan.
7. Lifetime allowance is recyclable
There is another important feature of the lifetime allowance. It is possible to recycle it. What this means is that even if you use up the full lifetime allowance of 18 million yen, if you sell, say, 3 million yen out of it, another 3 million yen will be restored to the lifetime allowance. See Chart 7.
Chart 7: Recycle of Lifetime Allowance
This feature of recycling of lifetime allowances makes the new NISA the almighty investment vehicle that will meet your various life event needs throughout your lifetime.
Let's say you're in your 20’s and 30's and you use a NISA to prepare for your home purchase up to the full 18 million yen. If there were dividends paid or unrealized gains, your NISA account balance would be higher than this amount. So, you buy a house and cash out the 18 million yen, plus the investment returns from your NISA account. The balance in the NISA becomes zero, at which point your lifetime contribution limit of 18 million yen is reinstated*³.
*³ Lifetime limit is reinstated the year after the sale.
Later in your 40’s and 50’s you can use the NISA to accumulate your retirement provision. Or when you retire in your 60’s and receive a sizable amount of retirement benefit from your company, you can put it into the NISA (using the 3.6 million yen annual contribution limit over a few years). You manage your investments and then gradually withdraw money from the NISA to fund your life in retirement.
8. NISA or iDeCo?
Japan has what is called the iDeCo (Individual-type Defined Contribution Plan) as a tax benefit scheme for retirement provision. Since the iDeCo is for retirement, you cannot, in principle, withdraw money from the plan before the age of 60. As a result, many people, especially younger people, are reluctant to use it. In addition, you have to pay an account management fee for the iDeCo.
NISA, on the other hand, has no such restrictions and allows withdrawals at any time. There is also no fee charged. You are not allowed to make contributions to the iDeCo over the age of 60 in general*⁴, but again, the NISA has no such age restriction.
*⁴ Some people may make contributions to iDeCo up to age 65
In the past, people have wondered whether to put money into a NISA or an iDeCo. Of course, some people can afford to put money into both schemes. But for those who could not, they had to make a choice of one or the other. Now, with the introduction of the new NISA's lifetime contribution limit and the ability to recycle the allowance, money that previously went into an iDeCo may find its way into a NISA*⁵. The lifetime limit of 18 million yen could be large enough for many Japanese as a retirement provision, considering the additional social security old age pension programs.
*⁵ Only lifetime investment limits can be recycled, not annual investment limits.
Of course, iDeCo has some tax benefits that NISA doesn't, such as contributions being deducted from gross salary income. After fully understanding the advantages and disadvantages of both programs, it is a good idea to consider how to best exploit the new NISA.
On Fidelity's site: https://retirement.fidelity.co.jp/white-papers/new-nisa/
We do not reply to your feedbacks.
If you need a reply from us, click here.