Rachel Reeves pauses cash ISA changes after backlash
Rachel Reeves has put her plans to reform cash ISAs on hold after speculation that she was considering reducing the allowance for tax-free cash savings was met with criticism from banks and building societies.
Savers have a £20,000 annual allowance which can be split across ISA types, but the most frequently used version is the cash ISA, which gives people a tax-free savings account. However, the government wants to encourage more people to start investing, to generate better long-term returns.
Next week, the chancellor was expected to use her Mansion House speech to cut the limit on how much money could be put in the cash ISA product annually and potentially announce changes to the Lifetime ISA too, but that reform will now have to wait, with reports saying Ms Reeves wants to continue to consult with industry experts amid conflicting ideas on how to proceed.
What did Ms Reeves want to do and why?
More than £300bn is currently held in cash ISAs, earning interest – but often at underwhelming rates. While some accounts now offer interest above 4.5 per cent, which outpaces the current inflation rate of 3.4 per cent, many savers are earning far less. As a result, their money may not be keeping up with inflation, leading to a loss in real value over time.
Cutting the limit from £20k to £5,000 a year, as had been speculated, was intended to be a way to encourage people to put excess cash savings into investments instead.
“Our ambition is to ensure that people’s hard-earned savings are delivering the best returns and driving more investment into the UK economy,” said a Treasury spokesperson.
Why were plans criticised?
First of all, there is little to suggest that people would divert spare savings straight into investing if they don’t already do so.
The Building Societies Association (BSA) wrote this week to Ms Reeves to urge her not to reduce the cash ISA limit, saying those who didn’t invest yet needed better advice and education to encourage behavioural changes.
“Simply changing ISA limits is unlikely to encourage people to invest, but it will hurt people who are responsibly saving for short-term goals, where investing may not be appropriate,” read the letter.
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Additionally, there’s little reason to believe that if people did invest, that money would go into UK businesses or provide them with any extra funds. Buying shares for private (or retail) investors typically takes place on exchanges where they would simply buy those shares other people are selling.
More importantly, stamp duty costs on buying British-listed shares are seen as a bigger barrier to domestic investment – a 0.5 per cent charge is placed on purchases, whereas there is no such cost to buy stock in companies based in the US or Europe.
What does it mean for savings?
For now, nothing has changed – if you use a cash ISA you can continue to do so for a maximum of £20,000 a year, though most people do not max out their allowance.
If the ISA allowance was cut, it could run the risk of people paying more tax due to fiscal drag: extra savings outside an ISA would count towards total income, which may push people over tax thresholds, reduce their tax-free interest allowance and thus get taxed on a large chunk of interest earnings.
Within an ISA, no gains are taxable whether interest payments, dividends or capital growth.
Interest rates are expected to be further cut when the Bank of England’s MPC next meets in August.
