Is the government going to change ISA rules? What you need to know

Why is the government looking to reform ISAs?

Since the start of this year, speculation has been rife that Chancellor Rachel Reeves might be planning an overhaul of ISAs, with the possibility that she may limit subscriptions to Cash ISAs, potentially to as little as £4,000, being the main focus of attention. In her March Spring Statement, the Chancellor confirmed that she was mulling options for reforms to Individual Savings Accounts (ISAs) to achieve the right balance “between cash and equities to earn better returns for savers, boost the culture of retail investment, and support the growth mission”. 

Since then, speculation that the amount that can be subscribed to a Cash ISA may reduce has escalated to new heights. While the Chancellor recently confirmed to the BBC that the overall £20,000 ISA allowance will remain intact, she remained pointedly tight-lipped on the fate of the Cash limit. The Chancellor is expected to launch a formal consultation into reforming ISAs this summer, possibly at her Mansion House speech in July, opening up the prospect of changes being announced at her next Budget. 

What potential changes could be made to Stocks & Shares ISA rules?

While the Cash ISA has been grabbing all the attention, ISA reform could potentially go much further with an overhaul of the Stocks & Shares ISA rules too. After all, if part of the rationale is to ‘support the growth mission’, might the Chancellor also require Stocks & Shares ISAs to be refocused, wholly or partially, on UK assets? 

Such a move would be consistent with the Chancellor’s desire to see greater allocations by pension funds to UK assets which has started with the recent Mansion House Accord, an agreement by the UK’s largest workplace pensions, to allocate at least 5% of their portfolios into UK private market assets by 2030. And in the last week of May, the Treasury confirmed explicitly that “the government will take a reserve power in the Pension Schemes Bill to set binding asset allocation targets”.

In ditching the previous Government’s plans for an additional £5,000 ‘British ISA’ solely focused on UK equities, the Government may have concluded that much more capital could be driven into the UK markets by reshaping the core ISA allowance rather than an extra one on top. After all, there is an argument that if the Government is going to provide tax incentives to investors, why should these end up being primarily used to invest in overseas companies? 

How have financial institutions reacted?

While the Chancellor has offered no firm clues on the matter, the lobbying for a refocusing of Stocks & Shares ISAs substantially on UK equities has begun from certain investment banks, brokers and fund managers who work in the UK equity markets. In recent years, the UK has seen a dearth of IPOs, and a steady stream of companies moving their listing to overseas exchanges where they can invariably command higher valuations. This has seen the number of fully listed companies on the UK markets decline by around 20% over the last five years** .  
 
In May, investment bank Peel Hunt, one of the firms who had advocated for the British ISA, published a 21-page note titled, ISAs: how to encourage savings and growth in the UK, arguing for reducing Cash ISAs, simplifying the range of ISAs by ending Lifetime ISAs and the Innovative Finance ISA, and refocusing Stocks & Shares ISAs on UK investments. Peel Hunt argue that with ISA tax reliefs estimated at around £9.4 billion, “a focus on productive assets and the UK would deliver better returns for taxpayers” and that “providing tax breaks for overseas investments makes little sense”. 

From a public policy perspective, you can see why refocusing ISAs on UK investments may prove compelling to a Chancellor who has talked much about the desire to drive investment into the UK. It would also help address the challenges facing the UK stock market, which has been impacted by pension funds dramatically reducing their ownership of UK shares since the late nineties and retail investors increasingly pouring money into US and global equities over the two decades.

How might this impact retail investors?

While these arguments for requiring a bias towards UK markets in exchange for the tax incentives, are undoubtedly strong when looked at through the lens of the Government (and for the banks, brokers and fund managers that operate in the UK markets), the case is less convincing from the perspective of the retail investor. 

Any potential moves that would reduce flexibility and limit the ability to diversify an ISA portfolio globally would be a retrograde step. On the one hand, directing capital into UK assets could improve the returns from UK equities, but the cost of limiting access to other markets within ISAs would likely reduce overall portfolio returns. Such a move, were it to happen, would effectively turn the clock back to the old days of Personal Equity Plans, where ISA-like tax incentives were originally targeted at UK and EU equities and where there were limits on how much could be invested overseas until PEPs were replaced by ISAs.

Who might benefit from the changes?

Of course nothing could come of this but should Stocks & Shares ISAs end up being refocused wholly or partially on UK equities and bonds, a potential beneficiary could be the UK’s investment trust sector. It has faced its own headwinds in recent times with trusts trading wide discounts, activists targeting companies and very little new share issuance. Under a Stocks & Shares ISA regime where investors might be required to invest at least a chunk of their allowance in UK listed investments, London Stock Exchange listed investment trusts that invest their portfolios overseas might suddenly find a welcome new source of demand. 

While some may argue that such vehicles would surely be screened out of being eligible, the Government should be entirely relaxed about this. After all, the UK equity market has an abundance of companies that operate principally or entirely overseas, but bring vitality, deal flow and earnings to the UK stock market, the City of London and other financial services centres such as Edinburgh. Only last summer Labour indicated it would be supportive of Chinese retailer Shein listing on the UK market. Revitalising the UK markets through more listings and fund raisings would benefit the City and UK financial services sector, which generate significant tax revenues for the UK.

Other ways to get greater investment into UK markets

While a reduced cash ISA allowance and greater restrictions on where Stocks & Shares ISAs can invest, would certainly prove contentious, there are other measures that would help encourage greater investment in the UK markets. For example, ISAs are supposedly tax-free, but investors can still end up paying stamp duty (a transaction tax) on the purchase of UK shares. Scrapping stamp duty within ISAs would be a good start to removing this friction cost altogether, as no such transaction tax like this exists when investors buy US shares. 

The Chancellor might even consider a bolder move such as providing a modest income tax credit or top-up ‘bonus’ for subscriptions into Stocks & Shares ISAs, subject to claw back if sold within a minimum time period. For now, we will just have to wait and see as to what might emerge in any future shake-up of ISAs, but as it stands, it makes sense to make use of these valuable allowances while the current rules remain flexible.

The value of investments can fall as well as rise and that you may not get back the amount you originally invested.

Sources
* Annual Savings Statistics, September 2024
** Peel Hunt estimates, 2024