ISA reforms are coming. While some of the finer details are still being ironed out, savers and investors need to start preparing for next April.
This article isn’t personal advice. ISA and tax rules can change, and benefits depend on your circumstances. If you’re not sure that an action is right for you, ask for financial advice.
What ISA reforms are coming in 2027?
From 6 April 2027, the Cash ISA allowance will be cut to just £12,000 for savers under the age of 65. Those wanting to make full use of their annual £20,000 ISA allowance can choose to either invest it all or subscribe up to £12,000 to a Cash ISA and open a Stocks and Shares ISA to invest the rest.
Other changes include a ban on transfers from a Stocks and Shares ISA to a Cash ISA, unless you’re over the age of 65, though transfers the other way around will still be allowed for all savers.
There will also be significant changes to the handling of cash in a Stocks and Shares ISA.
Under the new rules, any interest earned on cash balances will incur a flat 22% charge – in line with the new savings income tax rate for basic rate taxpayers applicable next financial year – from the moment the reforms go live on 6 April 2027. This rule change was introduced to deter investors from circumventing lower Cash ISA limits by holding cash in their Stocks and Shares ISA instead.
Cash-like investments, such as money-market funds, will still be permitted, but they must not comprise 100% of the Stocks and Shares ISA portfolio, or the holding will be considered a ‘non-qualifying investment’. This makes it complicated, as investors must ensure that part of their Stocks and Shares ISA is invested in other qualifying assets, like shares. Remember, none of these reforms apply to Junior ISAs or the Lifetime ISA.
Will these ISA reforms encourage more people to invest?
Encouraging people to invest is vital, but too much complexity can be a deterrent.
The Government’s rationale for the reforms aligns with its wider mission to get more people investing in the stock market. But there are concerns that this could have the opposite effect.
For many people, saving is the first step on their wealth building journey. They accumulate savings, enjoy the compounded returns delivered by a competitive interest rate, and establish a financial safety net.
Once cash savings are adequate to cover at least three to six months of emergency expenses, rising to around 12 months' essential spending in retirement, and enough to take care of any unexpected costs that life can throw at us, a savvy saver will typically seek out higher returns by investing any surplus in the financial markets over the long term.
For many of our more than two million clients, we already know that cash is where this journey begins. One in six HL clients who open a Cash ISA go on to open an investment product within six months.
This demonstrates the important role that Cash ISAs play.
They are the first stepping stone in many people’s financial journey, helping investors gain confidence before taking the next important step into investing, which has the potential to generate returns superior to the interest earned on cash savings. Although the value of investments can go down as well as up, so you could get back less than you invest.
But some people need more of a nudge than others to take that next step, which is why tightening the rules on cash and creating more complexity risks derailing that journey altogether.
The potential downsides of the new ISA rules
Preventing transfers from Stocks and Shares ISAs to Cash ISAs when needs arise may leave some savers feeling trapped in a product. It may even inadvertently encourage them to hoard more cash than they need. They may abandon tax wrappers altogether and divert more funds to bank accounts, where they could suffer from worse interest rates and be liable for tax charges on the interest they earn if they breach their Personal Savings Allowance.
There are also legitimate reasons for holding money in cash for short periods within a Stocks and Shares ISA – reasons like wanting to use up your allowance before the tax-year-end deadline and taking time to make an investment choice. Others may want to pause new investment decisions during volatile periods or de-risk a portfolio ahead of a major, planned expense.
How savers are responding to the reforms
For now, the response appears relatively subdued.
Research from Opinium in June shows that, of 2,000 people, 12% are looking to open and contribute to a Cash ISA before the changes take effect, and 11% plan to prioritise using their full Cash ISA allowance. Those numbers increase more sharply among younger age groups, rising to 24% and 15%, respectively, among 18- to 34-year-olds but drop off to 5% and 8% among the over 55s, reflecting the fact that over 65s are unaffected by the Cash ISA cap.
The extent to which the reforms are encouraging people to invest also appears limited.
Only 9% of respondents plan to shift their focus towards a Stocks and Shares ISA, rising to 16% for 18- to 34-year-olds. Again, the over 55s are even less inclined to make a move at 3%, though this is to be expected as a larger proportion are already likely to be investors.
Perhaps more of a concern is that a third of non-investors have no plans to change their savings approach at all, suggesting that, at least for now, the changes will fail to deliver the desired behavioural shift anyway.
The Government recently closed its technical consultation on the ISA anti-circumvention reforms, and during that process we reiterated our position that penalising prudent savers would not create investors. We now await the outcome.
What ISA holders must consider now
As we edge closer to the implementation date, some ISA holders may have key decisions to make before the rules change. This includes investors who like to retain a percentage of their portfolio in cash, for example, or someone who needs cash for an imminent large expenditure, such as a house deposit.
Those who have received a lump sum through a bonus, inheritance, financial gift or other windfall may also need to consider their approach.
Remember, the reforms should never derail effective saving and investment decisions, and making full use of your annual tax-free allowances remains a key financial planning strategy. However, some choices may require more careful consideration in the run-up to the reforms.
The starting point for any decision comes down to the basics of personal finance – what do you need the cash for?
Cash should be held in the right place, for the right reason, in the right amount for your personal circumstances.
For someone with limited financial reserves, whose priority is building an emergency pot, making full use of the current £20,000 Cash ISA allowance while it is available may be key.
Beyond the recommended sum required to cover three months of essential expenses, unless the money is needed for a significant near-term expense, then investing surplus cash to achieve greater long-term growth and inflation-beating returns should ideally be the next objective.
The same rule applies where cash is already held within a Stocks and Shares ISA. Unless the money is needed within the next five years, directing it towards investments that align with an investor’s financial goals and risk tolerance has the potential to make the money work even harder.
Meanwhile, money-market funds offer a possible solution for those who still want to retain a cash-like element within their portfolio.
Where cash is needed to cover more immediate expenses, savers still have a window to take advantage of current ISA transfer rules before they change.
It is crucial, however, that the money is transferred directly into a Cash ISA rather than withdrawn and then resubscribed. An ISA transfer preserves the tax wrapper status, whereas withdrawing the funds means any money later paid into a Cash ISA will count towards that tax year's ISA allowance.
Although the looming ISA changes risk undermining the simplicity of ISAs, sophisticated savers and investors must adapt to the rules and make moves that align to their financial objectives. The challenge will be ensuring that those at the start of their savings journey continue to take the next step and move from cash to investing with confidence.
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