New limits on cash ISAs and higher taxes on savings could affect how you manage your money. Paul Lewis explains what the planned changes mean and who will be hit hardest.
Individual Savings Accounts (ISAs) used to be simple. You could put cash in them or open an investment ISA for your shares and bonds and there would be no tax of any sort on the interest, dividends, or capital gains. But from April – under present plans – that is about to change.
Since 2017, you have been able to put a total of £20,000 a tax year into an ISA and that could all be in cash, all be in investments, or split between them. But, unless the new government changes the plan, from April there will be two different limits for cash ISAs depending on your age. People who are aged at least 65 by 5 April 2028 will still be able to put a total of £20,000 into cash or into shares or divided between them. But anyone younger – born 6 April 1963 or later – will be limited to putting only £12,000 into a cash ISA. If they want to put in more than that then up to £8,000 must be in an investment ISA. These restrictions are on new money going in not the total held in each, which can be up to any amount.
Common investments held in ISAs, such as shares, funds, investment trusts, ETFs, and bonds issued by companies or the government – including gilts – will all count as investments. But money market funds will not.
If you have an investment ISA, you will know that some of your money will be held in cash anyway because managers keep a float so they can buy and sell shares during the year. The government is concerned that people wanting all of their money in cash will cheat the limit by putting up to £8,000 in an investment ISA but telling the fund manager to keep it all in cash.
So, from April, any interest earned on cash which is held in an investment ISA will be taxed at a fixed rate of 22%. That is a flat-rate tax whatever rate of tax the individual normally pays and will be paid to HMRC by the ISA manager.
The individual is still not obliged to declare money or interest earned in an ISA to the tax man. That new tax on interest on savings held as cash in an investment ISA will apply to everyone – not just the under-65s – who has cash held in an investment ISA. And the under-65s will face a new ban on transferring money from an investment ISA into a cash ISA. That will not apply to anyone aged 65 or more during the tax year. And all ages will be allowed to transfer money from a cash ISA to an investment ISA.
Confused? Everyone is. There have been a lot of complaints from ISA firms about these new rules, which they say are complex and unnecessary. It is possible that the new Chancellor John Healey may announce changes in his first Budget this autumn.
Interest and dividends on cash or shares held outside an ISA are of course subject to income tax. And from April 2027 they will be taxed more heavily. The rates of income tax on interest earned on cash will rise by two percentage points. So it will be 22% basic rate, 42% higher rate, and 47% top rate.
This is the first time since the 1970s that unearned income has been taxed more heavily than earned income. The same rates will also apply to taxable property income from letting out homes, garages, driveways, and land. There will be no change to the existing reliefs on property income, including the rent a room tax free limit of £7,500 a year. If you have borrowed money to buy a rented property then tax relief on the interest will be given at 22%.
Tax rates on dividends are also rising from April by the same two percentage points. Basic rate taxpayers will pay 10.75% tax on dividends – up from 8.75% this year. And those who pay higher rate tax will pay 35.75%, up from 33.75%. Oddly, the top rate of tax on dividends stays at 39.35%. The first £500 of dividends in the tax year are free of tax. That allowance was slashed by previous Conservative governments. Not long ago, it was £5,000 and more recently was halved and halved again to £500.
These rates apply throughout the UK as income tax on savings interest, dividends, and property income is not devolved. The changes make it even more important to put as much of your savings or investments as you can into an ISA. Cash interest rates may be slightly less than those in taxable savings accounts but the tax relief makes the returns much better. If your cash ISA is paying less than 4% or so you should move it to a better paying one. You do that by opening the new ISA and telling it to transfer the old ISA in because if you take the money out of an ISA to reinvest it you lose its ISA status.
If you put investments into a shares ISA, remember to choose one with the lowest charges that tracks an index. Managed funds seldom outperform simple trackers, especially after charges and tracker charges are now very low.
The new Chancellor John Healey may, of course, change any of these existing plans. There is certainly a suggestion that the rates of capital gains tax (CGT) may rise further towards the rates of income tax.
Currently CGT is 18% for basic rate taxpayers and 24% for higher or top rate payers. There is also a £3,000 exemption on gains before the tax itself kicks in.
In a volatile world, politically as well as financially, it is important to keep your eye on your savings and investments to make sure they are safe and working as hard as possible for you. Move them every year to ensure that you maximise the return.
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