Will Rachel Reeves impose £4,000 cash ISA limit?

Savers could face an ISA overhaul as part of efforts by the Treasury to boost investment in UK stocks.

Chancellor Rachel Reeves has been meeting with the financial industry to gather ideas on boosting the UK economy and one solution could be reforming the ISA market.

It comes as the UK stock market remains unloved compared to its peers in the US and many companies are even favouring the New York Stock Exchange over London.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don’t miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Critics have highlighted rising taxes in the UK make it a less attractive environment for companies to operate in.

Reeves is trying to encourage growth in the UK economy and plans include creating pension megafunds that will back British infrastructure projects.

But the latest idea is to revamp ISAs to encourage people to put more money into the stock market rather than leaving it in cash.

Here is what we know so far.

Are ISAs being scrapped?

Currently, the annual ISA allowance is £20,000.

This can be used across cash ISAs and stocks and shares tax wrappers.

According to reports, financial lobbyists have suggested that the Treasury should overhaul the savings market and either lower the cash allowance to £4,000, scrap cash ISAs or just create a new tax-free product that encourages investment in the UK stock market.

The argument is that this would free up the £294 billion currently held in cash ISAs to be put to better use backing British brands.

There is currently £456 billion invested in stocks and shares ISAs.

There is of course no guarantee that encouraging more into stocks and shares ISAs would benefit UK stocks though, especially as the government has already scrapped plans for a British ISA.

The pros and cons of a cash ISA

Higher interest rates have made cash ISAs more attractive in recent years. Savers get the security of fixed return and it is tax-free.

But they could lose their appeal as interest rates continue to drop.

They also may struggle to beat inflation, unlike investing in the stock market.

Even without an ISA, savers benefit from a personal savings allowance at £1,000 per year for basic rate taxpayers and £500 for higher earners.

Research by Quilter suggests many savers are losing money in real terms by keeping funds in a cash ISA.

Someone who invested £10,000 in a cash ISA in December 2012 would currently have £11,955. Adjusted for inflation, this is just £7,918, according to research by the wealth manager.

In contrast, a £10,000 investment in the IA Global Equity index over the same period would be worth £33,526 or £22,221 after inflation.

Holly Tomlinson, financial planner at Quilter, said: “Following a relatively rare period of cash ISAs delivering above inflation returns, we are now back to people losing money in real terms by keeping their money in cash.

“Rumours have been swirling that the government might scrap or scale back cash ISAs, which would be a clear push to shift the UK’s savings culture towards investment.

“That’s not necessarily a bad thing as too much wealth sits in low-yielding cash when long-term investing could deliver better returns and fuel economic growth.

“While this data shows that cash ISAs are not the best place to save to get the best returns, these types of accounts still have their place. Your saving goal might be in the short-term meaning you can’t take on the inherent risk that comes with investing.”

Rob Morgan, chief investment analyst at Charles Stanley, said many people hold too much in cash and not enough in investments, which is a “missed opportunity to drive long term wealth creation”.

He added: “This reticence has negative ramifications for the success of the UK stock market and the wider economy too.

“While cash is exactly what is needed for building short term financial resilience through an emergency fund and saving for shorter term goals, it fails to drive household wealth meaningfully forward over the longer term.”

If cash ISAs were axed or limited in some way in favour of stocks and shares ISAs, Morgan suggests those wanting cash-like returns in exchange for little risk could mitigate the move by investing in areas such as short-dated gilts or money market funds.

He added: “That would require some level of knowledge, or perhaps advice or guidance, to achieve the desired objectives, but it could undermine the objective of incentivising greater long-term investment in the stock market specifically.”

Tomlinson suggests the approach to the cash ISA should be reform, not removal.

She said: “Capping tax-free cash savings or improving incentives for investment ISAs could strike the right balance. The UK does need to boost its investment culture, but that shouldn’t come at the expense of savers who rely on cash for stability.”