In a significant move that will affect millions of savers across the UK, Chancellor Rachel Reeves has announced a substantial reduction to the tax-free cash ISA allowance in today's budget announcement.
The Budget Changes Explained
The annual limit for cash ISA contributions will be reduced from £20,000 to £12,000, representing an £8,000 cut to the tax-free savings allowance. This change is scheduled to take effect from April 2027, giving savers time to adjust their financial planning.
However, there's important protection for older savers. People aged 65 and over will be exempt from the reduction and can continue to use the current £20,000 annual allowance. This exemption recognises the different financial needs and risk profiles of retirement-age savers.
Impact on Your Savings Returns
The reduction could significantly affect the interest earned by savers, particularly those who prefer the security of cash ISAs over riskier investment options.
Consider this example: if you have £20,000 to save and choose a one-year cash ISA paying 4.28%, under the old rules you would earn £856 in tax-free interest. With the new £12,000 limit, your interest drops to £513.60 from the cash ISA portion.
The remaining £8,000 would need to go into a taxable savings account. Even if you found a bond paying 4.5%, after basic rate tax deduction the effective return drops to 3.6%, generating only £288. Your total interest across both accounts would be £801.60 - £55 less than under the current system.
The impact is even more pronounced for higher-rate taxpayers, who could see their total returns fall from £856 to just £729.60 in the same scenario.
Why Is This Change Happening?
Chancellor Rachel Reeves aims to encourage more people to consider investing through stocks and shares ISAs rather than keeping large amounts in cash savings. The government hopes this will stimulate economic growth and investment in British businesses.
However, experts question whether this approach will work. Cash ISAs remain significantly more popular than their investment counterparts, with approximately 14.4 million people holding cash ISAs compared to just 4.2 million with stocks and shares ISAs.
Tom Selby, director of public policy at AJ Bell, warned before the budget that "tinkering with the cash ISA allowance would be an ineffective way to promote investing" and could add complexity to the savings system.
Broader Consequences and Concerns
Financial institutions have raised concerns that reducing cash ISA limits could have unintended consequences. Banks and building societies use money deposited in cash ISAs to fund lending to customers, including mortgages. Some experts worry that reduced deposits could potentially lead to higher mortgage rates.
There's also concern about the psychological impact on savers. Adam French of Moneyfacts noted that while the average cash ISA deposit was just under £7,000 in the 2023/24 tax year, the change could create confusion and anxiety among savers.
Selby warned it might foster a "scarcity mindset" where people feel pressured to use their allowance or lose it, potentially leading to poor financial decisions.
On a positive note, Martin Lewis of MoneySavingExpert clarified that the new limits typically only apply to new contributions, not money already saved in existing cash ISAs.
The full ISA allowance across all types - including cash, innovative finance, and stocks and shares - remains at £20,000. Savers who reach the £12,000 cash ISA limit can still use the remaining £8,000 allowance for other tax-free savings vehicles if they're comfortable with different levels of risk.
