Chancellor Rachel Reeves is set to announce plans to reduce the annual allowance for Cash Isas later this month, according to reports.
According to the Financial Times, government sources have confirmed that the chancellor intends to lower the Cash Isa allowance, marking the first major change to Isa limits since the 2017-18 tax year.
It is believed that discussions are still ongoing regarding the exact reduction to Cash Isas, but the move is part of a strategy to encourage people to invest more of their savings. Reeves is expected to make the announcement in her Mansion House speech on 15 July.
Isas allow individuals to save or invest up to £20,000 a year tax-free, although there are different limits for specific types of Isas.
It is thought the plans are aimed at encouraging people to invest more of their money in the stock market with a view to earning higher returns in the long term.
What is a Cash Isa?
A Cash Isa (Individual Savings Account) works like a normal savings account but is a more tax-efficient way of saving.
It’s regarded as a stable and reliable way of saving, because your money isn’t be invested in the stock market (and therefore subject to market volatility), and you don’t pay income tax on the interest you earn.
There are two main types of Cash Isas: variable and fixed rate. Fixed rate Cash Isas offer slightly higher rates than variable ones, but normally come with the condition that you can’t withdraw your cash before the end of a fixed term.
There are four other types of Isas: Stocks and Shares Isas, Innovative Finance Isas, Lifetime Isas, and Junior Isas for children.
HMRC statistics reveal that, in the 2022-23 tax year, more than 7.8 million people held Cash Isas, compared to 3.8 million with Stocks and Shares ISAs (also known as investment ISAs).
Bank of England figures show that savers deposited a record £14bn into Cash ISAs in April this year, the highest amount ever recorded since the product was introduced in 1999.
What are the possible changes?
Every tax year, you can save up to £20,000 in one Isa or split the allowance across multiple Isas, without paying any tax on their interest or earnings.
Savers can choose how to divide the tax-free limit between any of the accounts outlined above.
The change mooted would mean savers would be limited in how much money they can put into Cash Isas, with reported reductions between £4,000 and £5,000 a year.
It is not clear if any of the other types of Isa will be affected.
In May, Reeves insisted she had no plans to reduce the £20,000 limit on the amount that can be put into Isas each year, saying: “Very few people are able to save £20,000 a year… we still want people to be able to save and I’m certainly not going to reduce that limit.”
However, she did not rule out restricting tax-free investments into Cash Isas at the time.
What impact would this have on savers?
It is unclear exactly how the reforms this will affect savers’ habits, but it could attract more investment into riskier Isas or stop people investing all together.
Sarah Coles, from Hargreaves Lansdown financial services, believes the changes may leave less money for investors to transfer from savings to investments.
“Cash Isas are often a first port of call when people are starting out, and they’ll often gradually move over into investments as they find their feet.
“Reducing the allowance means savers have less available to transfer into Stocks and Shares ISAs when they become comfortable with investing – effectively reducing investments rather than boosting them.”
Why is Rachel Reeves doing this?
Reeves has said that the changes would represent a better return for British investors, whilst some in the city believe the changes will attract growth for British companies.
Reeves said last month: “I do want people to get better returns on their savings, whether that’s in a pension or in their day-to-day savings.
“And at the moment, a lot of money is put into cash or bonds when it could be invested in equities, in the stock market, and earn a better return for people.
“But I absolutely want to preserve that £20,000 tax-free investment limit that people can make every year.”
At the end of the 2022/23 tax year, UK adults held a total of £725.9 billion in Isas, according to Gov.uk, which could represent an increase in tax yield, and help balance government’s books.
It is hoped that by encouraging more investment into stock and shares ISAs British companies and the City of London will benefit.
UK investment bank Peel Hunt has suggested the cap on cash Isas should be slashed from £20k to £5k to promote a transfer of savings into shares.
A report by the bank stated “Savers would benefit from investing in equities given the long-term track record of outperformance of equities vs cash.”
What the critics say?
Martin Lewis, said the changes would be a “big mistake” should the Chancellor introduce them later this month.
Writing on X, Lewis said cutting the cash ISA was a form of “p*ss people off economics” and while he was in favour of encouraging people to invest, this was not “the route to do that”.
“My suspicion is that for many who use cash ISAs, it will just result in many having to pay more tax on their relatively paltry savings interest, not have an epiphany and think ‘oooh i’ll just fill up the remainder of my ISA allowance with investments instead’”, he wrote.
“I’ll be disappointed if the chancellor chose to listen to the big investment firms in the City, and shut down many building societies and consumer groups who’ve said its not a good route.”
A recent survey commissioned by investment platform AJ Bell found that just one in five savers would invest more in the UK stock market if the Cash ISA allowance was cut.
AJ Bell director of personal finance, Laura Suter, says: “In the long run, however, there is considerable doubt that a cut to the Cash Isa allowance would deliver a shot in the arm for the UK stock market.
“Over half (of those surveyed) would simply put their money into a taxable savings account. Good news for a chancellor hungry for money, less so for the London Stock Exchange.”
Andrew Prosser, head of investments at InvestEngine, said: “Simply altering the cash component of ISAs is unlikely to have the intended impact of getting more people investing.
“The two age groups most likely to contribute to a cash ISA are aged 25-34 and 65 and over. Younger savers are likely using cash or lifetime ISAs to fund big life purchases like a house deposit, while older savers may use them to fund short-term spending needs.
“Neither of these groups will want to see the value of their funds fluctuate as it would with investing. It’s more likely that they simply continue to hold the same amount of cash, but more of it would be outside the ISA tax wrapper.”
