How will Labour shake up the ISA regime?

Let’s hark back to the 2014 Spring Budget, an event that delivered several earth-shattering changes to the personal finance landscape.

The most memorable was, of course, pension freedoms, but then-chancellor George Osborne also gave the individual savings account (ISA) regime a good shake-up.

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The annual ISA allowance went up from £11,520 to £15,000 - the largest-ever increase - and for the first time the limits for cash and stocks and shares versions were equalised.

The latter measure proved particularly significant. In the 2013-14 tax year, you could only stick £5,760 into a cash ISA, meaning to max out your allowance, at least half had to be invested.

Osborne’s aim was to make things simpler, something the current government has pledged to fine tune. But Rachel Reeves has been urged to return some aspects to the way they were – notably reduce or scrap the cash ISA allowance. More on that shortly.

Since assuming power, Labour has already made some key decisions about the tax wrapper’s future. And we can expect further adjustments during the current Parliament as Keir Starmer’s party ramps up its quest to improve the ISA landscape. Given the popularity and importance of ISAs in portfolio construction, developments here will be closely watched and scrutinised.

So, how might the ISA world change over the coming years?

Cash ISA allowance under threat?

Reports surfaced last week that City investment firms are lobbying Rachel Reeves to slash the Cash ISA limit in a bid to encourage more people to invest rather than park their money in savings.

Proponents of this idea point towards two benefits.

First, while history tells us that the stock market outperforms cash deposits over longer periods, this message is failing to reach large swathes of the population. New City minister Emma Reynolds recently raised concerns about people being risk-averse: “We have failed to drive an investment culture that we see in other places that allows people to invest their money,” she said, suggesting inflation will harm those who swerve the stock market.

Second, with less scope to save tax efficiently in cash, more money will flood into the stocks and shares version, boosting the UK economy, a task we know is firmly on the chancellor’s radar.

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Unsurprisingly, not everyone is enamoured with the concept. Building Societies Association chief executive Robin Fieth fired back at the suggestion that swelling cash ISA balances stymies economic growth: “Banks, building societies, credit unions and other providers use the deposits to fund loans to households and businesses,” he said, going further: “Substantially reducing the role of cash ISAs would have knock-on impacts on the price and availability of these loans if providers had to replace the funds from other sources.”

An obvious inference here is that it’s a case of financial companies looking after their commercial interests. Investment firms want a bigger share of the ISA pie and building societies don’t want to relinquish theirs.

Still, hacking away at the Cash ISA limit would be extreme. Not only may it be considered another tax grab in addition to the £40 billion in hikes announced at the Autumn Budget, but it could run counter to Labour’s bid to create a simpler ISA landscape – one that novice savers and investors can make better sense of.

Whatever your view on the debate, it does highlight an important matter: the need to choose the right ISA for your goals. Both stocks and shares and cash have important roles to play when it comes to supporting your financial future, but picking the wrong one can be harmful. A core task for the government is to help savers and investors get this decision right.

Lifetime ISA: scrap or reform?

As touched on above, we’ve seen several big ISA developments since Starmer picked up the keys to 10 Downing Street.

The British ISA was consigned to the trash, and the Treasury Select Committee launched a review to find out whether the Lifetime ISA is fit for purpose. Both developments have, by and large, been well received. In contrast, the government’s decision to freeze the annual ISA limits until 2030 proved less popular.

A thorough assessment of the Lifetime ISA’s viability in its current form is certainly long overdue. The product has clear and obvious appeal – you can pay in £4,000 a year, which attracts a 25% bonus. The catch is you must use the pot to buy a first home or fund your retirement.

The promise of a bonus may sound enticing, but there are some things to watch out for. The maximum you can spend on a property hasn’t budged from £450,000 in years, despite rising property prices, and its function as retirement savings product is debatable: you can’t take one out after age 40 and can’t pay into one beyond age 50.

If you don’t use the money for either purpose, you not only lose the bonus but also get slapped with an extra 6.25% penalty. Lifetime ISA early withdrawal charges totalled £75 million in 2023-24, according to HMRC data, underscoring the pitfalls of selecting the wrong ISA.

The big question now is whether Labour will improve the Lifetime ISA or scrap it. We should find out more soon.

The case for simplicity

With less than two months till tax year end, we’ve entered a crucial time for the ISA market. Savers and investors will be scrambling to make the most of their £20,000 allowance before it resets on 6 April.

The popularity with ISAs is clear. Any gains, interest and dividends are shielded from the taxman and, except for the Lifetime ISA, you can access the money anytime you like without penalty. What’s more, you have thousands of options to choose from in terms of funds, trusts, exchange-traded funds (ETFs), single company stocks, or deposit savings.

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The tax advantages have become more attractive since the Autumn Budget after the rates of capital gains tax (CGT) were increased from 10% to 18% at the basic rate, and from 20% to 24% at the higher rate. Anything you hold in any ISA is shielded from this tax raid.

While seasoned investors appreciate the significance of maximising their ISA before the current tax year runs out, it appears that others are less informed.

ii conducted some research recently and found that only around one quarter (28%) of respondents knew what tax year end was about. Elsewhere, some 17% said they have no idea what the term means, and a further 13% believed it applies only to wealthy people.

There’s clearly a need for an educational push here, one that may help to remedy the UK’s flailing investing culture. Calls from various quarters have urged the government to simplify the ISA regime to give people more confidence when it comes to selecting the right one for them.

There are currently six ISA types - stocks and shares, cash, Lifetime, innovative finance, junior and help to buy (although this is no longer open to new subscriptions) - which many feel poses a headache for some savers and investors, deterring them for making sound decisions with their wealth.

How to choose between cash and shares

If you’re weighing up whether a cash and stocks and shares version is right for you, let’s offer some steer on how to pick the right one.

If your specific financial goal is less than five years away, or you intend to use the money as a safety net, consider cash ISAs. These work the same as a standard savings account, but any interest you earn is tax free. The main risk is that if inflation outstrips the interest rate you receive, your wealth will erode in real terms. Over lengthy periods this can cause significant damage to your financial health.

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However, if you’re prepared to take a longer-term view, defined as five years or more, a stocks and shares ISA should be a better fit. Returns aren’t guaranteed and there’s a chance you might not get back everything you put in. But the chances of growing your wealth, and importantly beating inflation, are far higher than if you opt for cash.

If you’re stuck for ideas on how to invest based on your personal circumstances and attitude to risk, and need some guidance, our Managed ISA can help your money end up in the right place.