Investors in Isas are losing out on £240m a year because of a government refusal to boost their tax breaks, threatening to damage the schemes permanently as they mark their 10th birthday tomorrow.

The chancellor is being urged to raise the allowance for Isas in his April 22 budget as figures show disillusioned investors pulled £1.3 billion out of equity Isas between April 2008 and the end of last month.

They withdrew more than £100m last month alone — just as the stock market appears to be picking up. The FTSE 100 rallied 3.4% last week to 4,030 — the first time the blue-chip index has closed above 4,000 for six weeks.

The Isa allowance would be £9,000 today had it been raised in line with inflation, compared with £7,200 today, according to fund manager Fidelity. Refusal to link the threshold with inflation has cost investors an estimated £40m a year, it said.

Investors would have an Isa pot of £103,000 after 10 years had the allowance been lifted, compared with £93,000 otherwise, assuming 5% growth, according to accountant Grant Thornton. With another 10 years’ growth, the difference could be as much as £17,000.

Fidelity is also calling on Alistair Darling to reinstate the dividend tax credit, removed by his predecessor, Gordon Brown, in 2004 at a cost to investors of £200m a year. Over 10 years, the tax credit, worth 25% of dividends to a higher-rate taxpayer, would boost average returns by 8% or £339 a year.

Gary Shaughnessy of Fidelity said: “We believe the treatment of savers during the current financial crisis has been iniquitous, punishing the most prudent members of society.”

The poor performance of equity funds has also damaged the reputation of the tax-free investments: the average equity-Isa fund has fallen 1.98% in 10 years, but the average non-Isa fund is down 5.34% after basic-rate tax, according to data firm Morningstar.

However, some analysts believe this is the best time in a generation to buy shares, and investing within an Isa could have a big impact on returns — especially when you draw an income from your portfolio.

Suppose a higher-rate taxpayer invested the Isa maximum of £7,200 at the start of each year for 20 years, and their funds grew 5% a year.

They would have a pot of £249,979 within the Isa, compared with just £193,467 outside Isas because of the impact of income tax and capital gains.

If they drew an income of 5% in retirement they would earn £9,673 a year gross, or £5,804 after higher-rate tax, outside an Isa. Within an Isa, however, gross income would be £12,499 — more than double the amount they would get outside the Isa. We look at what else the government should do.

PERSONAL ALLOWANCES FOR PENSIONERS

Pensioners have been hit hardest by low interest rates as much of their income comes from savings. The over-65s benefit from a higher personal allowance, though there are calls for this to be raised further.

The personal allowance for those aged 65 to 74 will rise from £9,030 to £9,490 from tomorrow, while the allowance for those aged 75 and over goes up from £9,180 to £9,640. The allowance for those under 65 will be £6,475, up from £6,035.

Accountant KPMG has called on the government to increase the allowance to about £10,000. Some commentators also want all interest on building society and bank accounts to be tax free for pensioners.

SCRAP CLAWBACK

The government claws back the higher age-related allowance if your income goes above a certain level. In the new tax year, this will be £22,900, up from £21,800.

For every £2 in income above this, the Revenue knocks £1 off the age-related allowance, until it is reduced to the level for all people under 65. This creates in effect a marginal tax rate of 30% rather than 20%.

KPMG has also called on the government to scrap the clawback of the personal allowance for anyone earning more than £100,000, due to come into force in 2010.