The hidden dangers the autumn Budget poses to your ISA
The first Labour Budget in 15 years had stoked widespread fears that steep tax hikes would hit savers and investors the hardest. Although ISAs were left largely unscathed, there are some hidden dangers that all investors should be aware of.
Chancellor of the Exchequer, Rachel Reeves, had accepted that the budget would be ‘tough’ as Labour sought to address what the party termed as a £22 billion fiscal ‘black hole’ in the economy in their October Budget.
Fears over tax rises and ISA implications saw masses of savers scramble to either open an Individual Savings Account or maximise its annual £20,000 tax-free allowance for the 2024-2025 tax year.
In all, one in five UK residents opened a cash ISA or were planning to do so ahead of the Budget, while 18% were found to be adding more money into their savings accounts in the build-up to the event on October 30.
Other data compiled by Morningstar found that the number of customers maxing out their £20,000 allowance accelerated 65% between the beginning of July and the end of September, compared to the same period in 2023.
The biggest fear among savers was the impact of the Budget on the tax-free advantages offered by Individual Savings Accounts. When investing in an ISA, you’re fully exempt from capital gains tax, income tax, or any tax relating to the dividends you receive from a stocks and shares ISA.
Although the Budget’s major £40 billion tax hikes left ISAs relatively unscathed, there are a few hidden dangers that investors should be aware of. Let’s take a deeper look at how your Individual Savings Account may be impacted by the recent Budget:
Frozen allowance means less growth potential
The Treasury’s decision to freeze annual tax-free ISA allowances at their £20,000 limit for cash and stocks and shares Individual Savings Accounts, £4,000 for Lifetime ISAs, and £9,000 for Junior ISAs and child trust funds until 2030 could limit the earnings potential of savers in the future.
The upper limit for investments in ISAs grew multiple times throughout the 2010s, beginning the decade at a limit of £10,200 for the tax year and concluding with an allowance of £20,000 by 2017.
Since 2017, the limit to how much savers can add to their ISAs hasn’t changed. As we continue to contend with higher inflation and combative interest rates, keeping the Individual Savings Account allowance at £20,000 may become inhibitive as wages continue to rise and inflation devalues the impact that saving this much annually has.
With capital gains tax (CGT) creeping higher, the Budget may indirectly impact ISA investors by pushing their excess capital towards alternative investment strategies that don’t have the same tax-free status. While not quite a ‘stealth’ tax, keeping the £20,000 allowance for the remainder of the 2020s is likely to adversely impact the gains made by high tax band investors towards the end of the decade.
Missing out on a £25,000 ISA limit
Another change that impacted ISAs in the Budget was the confirmation of plans to scrap the creation of a British ISA. Originally announced by Conservative Chancellor Jeremy Hunt, the British ISA was designed to offer savers a £5,000 top-up to their £20,000 tax-free savings allowance, provided that their investments focused solely on UK firms.
Although the reception to Hunt’s plans for a British ISA was largely mixed, with some industry experts suggesting that it was restrictive and flawed from the outset, scrapping its development has meant that investors can no longer look to a prospective method of maximising their annual tax-free savings.
While the British ISA didn’t have many fans as a concept, scrapping plans for its launch means that we’ll have to wait until 2030 at the earliest to invest more than £20,000 per year tax-free.
Inheritance implications for ISAs
Crucially, ISAs lose their tax-free status on death, meaning that changes to inheritance tax (IHT) can directly impact beneficiaries should you die while contributing to your Individual Savings account.
ISAs can form part of your estate, and if you’re liable for inheritance tax, your savings will be subject to taxation too.
With Rachel Reeves announcing a freeze on inheritance tax thresholds at £235,000 or £500,000 for those leaving their home to their children, some older homeowners are already considering downsizing their properties in the wake of the announcement that unused pension funds will also be liable for IHT from April 2027.
In practice, this could cause your ISA to conspire against you in avoiding the standard 40% inheritance tax rate in passing down your estate.
However, it’s important to note that your ISA’s tax-free credentials remain in place and you won’t be liable for IHT if you’re passing your savings to your spouse or civil partner.
Navigating your ISA post-budget
Although your investing power for your ISAs could effectively weaken over time as the freeze on allowances lapses against inflation, the Budget has largely preserved the many tax-free benefits that investors can enjoy through Individual Savings Accounts.
By preparing alternative savings accounts to maximise your revenue streams and getting your estate in order sooner rather than later, you can navigate the changes posed by the Budget in good time for minimal disruption. With the rise of open banking, the way the entire payments ecosystem and the way we save money might change soon. ISAs are still one of the most effective ways for UK residents to save, and the Budget hasn’t changed their tax-free benefits for savers.
