Could Cash ISAs be scrapped?

The UK remains in an economic funk of muted activity, waning confidence and above-target inflation, an unenviable cocktail for Chancellor Rachel Reeves as she battles to keep to her fiscal rules.

Higher interest rates and slow growth are eroding the headroom between tax receipts and spending commitments. In the absence of taking on more debt or growth picking up, some combination of spending cuts and tax rises will probably be required to balance the equation. All eyes will be on the Spring statement next month to see what her next move is.

Already rumours have circulated concerning income tax and VAT, and more worryingly for savers, the Chancellor has reportedly been considering measures to curtail Cash ISAs in some way.

Is there a case for reducing Cash ISA tax breaks?

Cash ISAs are a popular and important product, especially with tax thresholds staying frozen, savings allowances frozen and interest rates much higher than a few years ago. There’s around £300bn sitting in these tax-free accounts, some of which could arguably be better directed towards other assets.

Sadly, lots of people in the UK hold too much cash and not enough in investments, which is a missed opportunity to drive long term wealth creation. 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.

Other assets – such as shares – don’t offer immediate security of capital, and you could get back less than you invest. Yet over long periods – five to ten years or more – leaving too much in cash could end up being more damaging to your wealth than taking risks with investments, even though it’s a bumpy ride at times. That’s because cash typically struggles to significantly outpace inflation.

Today savers are benefiting from high headline returns compared with a few years back, as well as easy, digital methods of moving money around. But they shouldn’t ignore the basic principle that keeping too much in cash can be counterproductive in the longer run. Even with the ability to easily switch between a Cash and a Stocks & Shares ISA as their needs change, few people choose to do so.

As things stand, if Cash ISAs were limited in some way in favour of Stocks & Shares ISAs, then 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.

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.

Could the government scrap Cash ISAs?

At this stage little has been said by the government on the matter. The Chancellor has just been considering ideas and meeting with industry leaders. However, she has reportedly ruled out scrapping Cash ISAs altogether, unsurprisingly as this would be a draconian move that would upend many people’s financial plans retrospectively.

However, paring back the extent to which people can contribute Cash ISAs looks possible and a two-tier system for cash and shares is not without precedent.

Today you can split the £20,000 overall annual ISA allowance in whichever proportion you like. But in the early days of ISAs an individual had the choice of a ‘Mini’ Cash ISA and a ‘Mini’ Stocks & Shares ISA, with limits of £3,000 each, or they could contribute up to £7,000 in a ‘Maxi’ Stocks & Shares ISA. The tax-free environment was therefore larger for those wishing to allocate to shares.

Although these rules were a bit complex, they did achieve the policy goal of incentivising long-term investing on top of saving, while still offering savers a tax-free environment. Further back in time there were separate systems for tax-efficient investment and cash accounts with PEPs and TESSAs.

Now that savers are familiar with the existing rules and the ISA ‘brand’ is well respected there is a strong case for retaining the status quo. Retaining confidence and stability in the financial system is vital and as a nation we are already not saving or investing enough.

It’s also important that those with shorter-term objectives or cannot tolerate any risk are not penalised. The Cash ISA is an important and well-recognised product for these people, and it can remove worries about reporting and incurring tax liabilities on interest.

What’s more, the money stored in Cash ISAs has some beneficial effects on the UK economy. While it’s not directly invested, it is often money that can be loaned out by banks and other providers to households and businesses.

Overall, there is a case for echoing the past with a larger annual ISA allowance to encourage investing on top of saving. However, this would have to be carefully considered so not to complicate the ISA system, which has grown more complex over the years.