How to reduce tax on your savings as the cash ISA limit is cut in the Budget ...Middle East

Chancellor Rachel Reeves is widely expected to cut the annual cash ISA allowance from £20,000 to £12,000 in tomorrow’s Budget.

The move is seen as part of a push to encourage savers into putting more of their money into stocks and shares and to help plug an estimated £30bn fiscal shortfall.

Talk of ISA reform has been bubbling away for months, and it comes after earlier reports put a £10,000 cap on the table.

Experts warn this could hit many savers, especially older ones, and even affect mortgage lending, with around 14 million people currently holding a cash ISA.

We take a look at what other tax-efficient saving routes you might turn to if your cash ISA allowance is cut.

Boosting pension contributions

Putting spare savings into a pension is one of the most tax-efficient alternatives to a cash ISA.

You receive tax relief on anything you pay in – effectively giving you a top-up from the Government.

The drawback is access as, for most people, money can’t be withdrawn until age 55 – rising to 57 in 2028 – and pension values can fluctuate depending on how they’re invested.

Still, for long-term savers, pensions remain one of the most powerful way to shelter money from tax.

When workers pay into a pension, they get tax relief at their marginal rate, meaning higher rate payers benefit the most.

Currently, basic rate taxpayers earning between £12,571 and £50,270 get a relief equal to 20 per cent of their pension payments to cancel out the income tax that might be due, while higher rate taxpayers earning between £50,271 and £125,140 get 40 per cent, and those earning above that receive 45 per cent.

Ian Futcher, financial planner at Quilter, said: “Contributions also reduce adjusted net income which helps people avoid tipping over key thresholds such as the high income child benefit charge or the point where the personal allowance is tapered away.”

Tom Selby, director of public policy at AJ Bell, added it’s important to remember that pensions are “long-term vehicles set up to enable long-term investing” and are not a “natural substitute” for short-term cash ISAs.

He said: “Anyone holding cash, be it in an ISA or a pension, for the long-term will be pretty much guaranteed to see the ‘real’ value of their money eaten away by inflation.”

Using a stocks and shares ISA

Stocks and shares ISAs keep the same overall ISA tax benefits, and you can still hold cash inside them if you don’t want to take on investment risk.

Futcher said stocks and shares ISAs are “often misunderstood” as something you must invest aggressively in, but in practice they can be flexible.

There are broadly two types of stocks and shares ISA platforms you can use – a do-it yourself (DIY) version, where you pick and manage your own investments, and a managed ISA, where a platform or algorithm builds and rebalances a portfolio for you.

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As for costs, DIY platforms can be very low cost. For example, Trading 212 has no platform fees while other platforms like AJ Bell or Hargreaves Lansdown charge a percentage of your ISA balance.

Managed ISAs typically charge a management fee on top of underlying fund costs – Wealthify, for instance, has 0.6 per cent per year after the first year for many plans.

Many providers also offer money market funds – cash funds – that are a short-term, lower-risk choice.

While value can still move up and down, these ISAs allow savers to preserve their full £20,000 allowance while keeping flexibility between cash and investments.

Futcher said: “If the cash ISA allowance is cut but the stocks and shares ISA allowance remains intact, many savers will find this a useful home for money that they want to keep sheltered from tax without taking on much investment risk. Similarly, there are much lower risk options for investing too.”

Research from interactive investor (ii) shows that confidence is a huge barrier to investing in the markets with many not sure how it works alongside the risk of losing money.

But “you don’t have to be an expert stock-picker”, Camilla Esmund, senior manager at ii, said.

She explained: “It’s about building a well-balanced portfolio for the long-term and staying invested.

“Also, if you’re in it for the long haul, the value of your investments will normally have time to recover from any temporary market dips.

“Ultimately, diversifying your portfolio with investments in different sectors, markets, and types of assets, is one of the most effective ways to manage risk.”

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Premium bonds and other tax-free savings options

Another option some experts point to is premium bonds with NS&I.

While returns aren’t guaranteed, any prize winnings are completely tax-free, making them attractive for higher-rate taxpayers or those whose savings interest already breaches their personal savings allowance.

Futcher said: “They can play a role as part of a short-term savings mix for people who want accessible money that is protected from tax without locking it up.”

The premium bonds prize fund rate is currently 3.6 per cent tax-free. This represents an average return, with the actual outcome depending on luck from the monthly prize draw where prizes range from £25 to £1m. The odds of winning a prize with any single £1 bond are one in 22,000.

Other NS&I products, such as tax-free savings certificates if reintroduced, could also appeal.

Though these options don’t replace the certainty of ISA interest, they can help shelter a portion of savings from tax without the long lock-ins of pensions or the volatility of markets.

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