Millions of retirees could be facing a major shake-up to their retirement income strategy as the Government considers reforms to cash ISAs – potentially even scrapping them altogether.
It is rumoured that Rachel Reeves could alter how Britons save, sparking fears that those who rely on cash ISAs for tax-free retirement income could be left worse off.
For more than two decades, cash ISAs have been a staple of UK savings, offering a simple, tax-efficient way to put money aside.
But as Labour eyes reforms and questions mount over whether these accounts should still enjoy tax breaks, retirees who depend on them may be forced to rethink their strategy.
Experts have warned that any overhaul could hit older savers the hardest, particularly those who have built up substantial ISA balances over the years.
Cash ISAs are considered a safe haven and are popular among retirees who have accrued a considerable pot of money.
According to the latest HM Revenue & Customs (HMRC) data, there were 3.8m cash ISA accounts held by savers aged 65 or over in 2021 to 2022.
Many have over £50,000 in their accounts and are still actively paying into them because of their tax advantages and simplicity, former pensions minister and partner at LCP, Sir Steve Webb, said.
The ISA, which stands for individual savings account, was created in 1999 and originally marketed for the tax break they provide.
But Sir Steve explained: “There are several elements of the income tax system which make savings interest more generously treated than earned income [payment from jobs].
“This includes, for example, the ability for basic-rate taxpayers to offset a £1,000 personal savings allowance against interest income.
“There is also a savings ‘nil rate band’ of up to £5,000 which means people just above the tax threshold shouldn’t need to pay income tax on their savings interest.
“So, although ISAs were originally marketed for the tax break that they provide, it’s only really relevant for higher-rate taxpayers or those with much larger amounts of savings income.”
Concerns are mounting that Labour’s proposed reforms could mean tighter restrictions – or even the abolition – of cash ISAs.
One suggestion is capping how much savers can accumulate in ISAs before losing their tax-free status, particularly as some individuals have built up six-figure balances.
The rationale behind this is that high earners may be using ISAs as a tax shelter rather than a simple savings tool.
But speaking to The i Paper, experts have warned that scrapping or limiting cash ISAs would be a major blow to retirees.
Ian Futcher, chartered financial planning consultant at Quilter, said: “If the rumours about scrapping or reforming cash ISAs prove true, it could significantly impact individuals who rely on these accounts for their retirement income.
“While it’s true that too much wealth in low-yielding cash can hinder long-term returns, cash ISAs still play a valuable role in financial planning.”
One of the biggest risks is that without cash ISAs, retirees could be forced into riskier investments, he said.
Money market funds within stocks and shares ISAs have been suggested as an alternative, but these carry a higher risk than traditional cash ISAs, as the value of investments can fluctuate.
One of the biggest criticisms of cash ISAs is that the interest rates they offer are often uncompetitive.
Banks and building societies sometimes use the tax-free status of these accounts as an excuse to offer worse rates than on non-ISA savings products, Sir Steve said: “Something else to note is that ISA providers sometimes offer pretty poor interest rates – in effect, they ‘capitalise’ the tax break.
“What I mean by this is that rather than have a non-ISA savings account offer 3 per cent, and an ISA offer 3 per cent, with the saver choosing the ISA because there is no tax, the ISA savings rate might be lower than 3 per cent.
“The saver might still choose the ISA because the after-tax interest rate is slightly more favourable, but they don’t in this case get the full advantage of the tax break – some of it has been ‘seized’ by the provider who is offering a lower rate than they would have done.”
This means that while savers might assume they are getting a great deal by avoiding tax, they could actually be earning less interest overall than if they had opted for a standard savings account.
He also raised concerns about whether the Government should be encouraging people to use cash ISAs as a long-term savings vehicle, adding: “As you will see from the stats, there are very substantial amounts held in cash ISAs, many of which are earning relatively low interest rates.
“Whilst everyone should have a cash balance of some sort, it’s questionable whether using a cash ISA as a long-term strategy is good, and whether the Government should be encouraging people to do so.”
Currently, the best easy access cash ISA rate is with Chip with a rate of 5.25 per cent for new customers for 90 days.
The best one-year fixed rate is with Close Brothers at 4.45 per cent.
If ministers move ahead with reforms, retirees may need to rethink how they structure their savings.
Options include shifting funds into stocks and shares ISAs, although this introduces risk, or making greater use of pension contributions, which offer tax relief but come with access restrictions.
Tom Selby, director of public policy at AJ Bell, highlighted another challenge – ensuring people can easily track their savings and pensions.
He warns that the UK’s pension system is already fragmented, with billions locked in lost pension pots.
Mr Selby said: “Automatic enrolment has successfully increased the number of people saving for retirement, but it has also exacerbated the problem of savers becoming disconnected from their retirement pots, with an estimated 3.1m pensions worth over £30bn estimated to be ‘lost’.”
The uncertainty around ISAs and pensions underscores the importance of clear government policy and the introduction of the much-anticipated pensions dashboard, which has faced long delays.
With cash ISA holders now facing the possibility of major changes, financial advisors stress the need for careful planning and diversification to ensure a secure retirement.
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