Chancellor of the Exchequer Rachel Reeves is reportedly considering plans to reduce the tax-free limit on cash ISAs from £20,000 to just £4,000.
The Telegraph has reported that the changes were proposed when Reeves met with senior city executives for a discussion on boosting economic growth. The plans aim to increase investment in stocks and shares by limiting tax-free cash savings options. In theory, savers would invest in a tax-free stocks and shares ISA rather than pay tax on their savings interest. The government is also hoping this will encourage a cultural shift away from cash savings and towards investments. Emma Reynolds, Economic secretary to the Treasury, recently told a House of Lords committee meeting: "Why have we got hundreds of billions of pounds in cash ISAs? We have failed to drive an investment culture."
What are the current ISA rules?
ISAs (individual savings accounts) allow savers and investors to shield their interest, dividends and capital gains from tax. The government limits how much you can put into an ISA each tax year, with the current maximum set at a total of £20,000. This applies across cash ISAs, innovative finance ISAs, stocks and shares ISAs and Lifetime ISAs (you can only contribute up to £4,000 in a given tax year to a Lifetime ISA). You can separately add £9,000 to a Junior ISA per child per tax year.
The interest, dividends and capital gains you earn from your ISA is not taxed, so making the most of the allowance each year is important to many savers and investors.
What would be the effect of cutting the cash ISA limit?
Supporters of the plan to cut the cash ISA limit to £4,000 argue that savers would invest the money they cannot put in their cash ISA, rather than put it in a savings account where the interest could be taxed. In theory, this would inject more money into the UK economy and boost growth.
It would also help those reluctant investors protect their money from inflation. While many people are attracted to the security of a cash ISA, especially since interest rates have risen from years of record-low levels, it is still common for inflation to outstrip the rate of interest paid out on cash. This means that while the amount of money in your cash ISA goes up each year, the value of that money is being eroded by inflation. The argument is that, over the long term, investments are able to beat inflation when cash is not.
Of course, many savers – including pensioners – are not putting money away for the long term and value stability, easy access and certainty over growth. These savers would be less likely to benefit from investing due to the inherent risks and fluctuations involved. Other detractors include banks and building societies that argue they rely on the money held in cash ISAs as a key source of funding, especially for mortgages and other lending. Cutting the cash ISA limit and reducing the amount of money held in cash by savers could therefore affect borrowing costs and mortgage affordability.
There is also scepticism that money invested in stocks and shares ISAs rather than saved in cash ISAs would boost UK businesses. It is possible to invest in a range of different businesses and funds through a stocks and shares ISA and currently no structure is in place to limit investments purely to British firms.
How is interest on savings taxed?
The main reason savers put their money in cash ISAs is to shield the interest they earn from tax. The personal savings allowance for a basic rate taxpayer is currently £1,000, which means you can earn up to £1,000 of interest on your savings in the tax year without having to pay tax on it. This allowance drops to £500 for higher-rate taxpayers and is reduced to zero for additional-rate taxpayers.
For example, a basic rate taxpayer with one of the top easy access savings accounts paying around 5% in interest would be able to hold around £20,000 in an account for a year before they started paying tax. Any more and the interest earned in a year would exceed £1,000 and the excess would be taxed.
This is why savers value maximising their ISA allowance, though there is an argument that the historic return on investments outstrips cash to the extent that you could be better off paying tax on your savings and using your ISA allowance to maximise your tax-free investments.
What are the benefits of a cash ISA?
A cash ISA allows savers to protect the interest they earn from tax and offers an alternative to the riskier option of investing in the stock market. Historically, investing provides better returns, but some people will value being able to access their money quickly over growing their pot. The risks involved with investing will also not suit certain people, as will the longer-term approach that most investors employ.
Cash is easier to understand than stocks and shares, but with record inflation levels still in recent memory it is understandable that the government is looking to shift the UK's preference for cash. Money to the Masses is dedicated to helping people make the most of their money and we have a range of articles for beginner investors. Here are some to check out:
- 'Are stocks and shares ISAs worth it?'
- 'How to open a stocks and shares ISA'
- 'What is a flexible ISA?'
- 'Lifetime ISAs explained'
MTTM AI (beta) 
