Rachel Reeves has received cautions regarding the potential repercussions of cutting or eliminating the cash Individual Savings Account (ISA), which may not necessarily lead to an increase in investment within the UK economy. Several financial firms in the City have been advocating for the limitation or total abolition of cash ISAs, suggesting that tax-free savings should be redirected towards the stock market instead. However, experts warn that such changes may not guarantee a surge in investments into UK shares.
Evidence indicates that UK investors have increasingly been reallocating their investments to foreign markets. This trend is largely attributed to low confidence in the domestic investment landscape, with many individuals lacking understanding or feeling hesitant to risk their money. A report from the House of Lords Library this year revealed that the proportion of funds under management allocated to UK companies has plummeted from 29.6% in 2008 to just 11.5% in 2023. In contrast, investments in overseas equities have risen significantly, from 28.1% to 42% during the same period.
Current Cash ISA Regulations
Presently, individuals can contribute up to £20,000 annually to either a cash ISA or a stocks and shares ISA, with profits exempt from both income tax and capital gains tax. While stocks and shares ISAs typically yield much higher returns over time, they also carry greater risks in the short term, as investments can fluctuate in value.
Reeves has indicated that she is contemplating instituting new restrictions on cash ISAs and has pledged to foster a stronger culture of retail investing in the UK when questioned about potential changes to tax regulations in the upcoming Budget. Laith Khalaf, head of investment analysis at AJ Bell, expressed skepticism, stating, “There’s no assurance that limiting cash ISAs will result in increased investments in shares, particularly within the UK market.”
Khalaf pointed out that UK equity funds have continued to experience significant outflows in 2024, with £13.1 billion withdrawn by investors, following a withdrawal of £13.6 billion the previous year. He attributed this trend to the “weak performance” of UK equities in comparison to global and US markets. “Ongoing and substantial outflows reflect the poor performance of UK equities relative to the US,” he noted, adding that investors are gradually reducing their historically high exposure to domestic markets.
Sarah Coles, head of personal finance at Hargreaves Lansdown, echoed these sentiments, stating, “Altering the cash ISA limit would not instantly stimulate more investment in a stocks and shares ISA, as the ISA framework isn’t the primary barrier to investment. For many, it boils down to a lack of confidence.” She further mentioned that even if individuals were persuaded to utilize their entire ISA allowance, two-thirds of cash ISA savers contribute no more than £5,000, indicating that there is no substantial pool of savings ready to be invested.
Interactive Investor (ii) has noted a shift among investors away from UK stocks in favor of international funds. Camilla Esmund, a senior manager at ii, remarked, “The so-called ‘home bias’ that once defined investor preferences appears to be diminishing, as individuals seek opportunities in faster-growing international markets. While the UK stock market hosts many world-class companies, its relative underperformance compared to global peers, especially the US, has pushed many to look beyond domestic options.”
Shaun Moore, a personal tax expert at Quilter, added, “The recent discussions around the potential reduction of cash ISAs to promote a culture of investing in the UK are intriguing but may not yield the economic benefits some expect. It is challenging to establish a direct link between abolishing cash ISAs and increased investment in UK companies via stocks and shares ISAs. Investors typically diversify their portfolios across various asset types, including bonds, money market funds, and international equities. Moreover, it is a considerable leap to assume that cash ISA savers will readily transition to investing.”
Last year, the Conservative government proposed a new UK ISA that would have permitted citizens to invest an additional £5,000 tax-free in UK equities, in addition to the existing £20,000 annual limit. However, this initiative was never implemented before the government’s departure from office, and Labour has not pursued the plan further.
Potential Strategies for Encouraging Investment
Experts have suggested several policy changes that Reeves could consider to cultivate a more robust investment culture in the UK. Khalaf proposed that the government could eliminate stamp duty on share purchases, a recommendation that has gained traction. Dan Neidle of Tax Policy Associates noted last year, “The UK’s 0.5% tax on share transactions is the highest among major economies. No other country with a significant stock exchange imposes a comparable tax. Stamp duty hampers the FTSE and raises capital costs for businesses.” However, Khalaf acknowledged that given the current financial constraints facing the government, including Reeves’s stringent fiscal policies, this move may not be “particularly feasible.”
Moore suggested another option could be to introduce additional tax reliefs for individuals investing in the UK. He stated, “There is an opportunity to explore further incentives to encourage investment in UK companies. The government could consider implementing additional tax reliefs, such as an inheritance tax exemption, to complement the existing income tax, dividend tax, and capital gains tax exemptions that ISAs already enjoy, provided that a portion is invested in the UK.” He emphasized that the ISA brand has thrived due to its simplicity and that it is crucial to preserve this aspect.
Coles added, “If the government aims to enhance investment in UK companies, there are simpler solutions available. The Chancellor could increase the stocks and shares ISA allowance, which would automatically boost UK investment. Additionally, the government could improve access to IPOs and secondary capital raising while abolishing stamp duty on UK shares to create a level playing field with overseas shares that do not incur this tax.”
