The UK government’s potential changes to cash ISA rules could result in savers seeking alternative solutions to maintain their tax-free savings.
Chancellor Rachel Reeves is reportedly considering a drastic reduction of the annual cash ISA allowance from £20,000 to £4,000 in the coming tax year. This change, if implemented, could push savers to explore proxy accounts as a workaround.
According to DevonLive, this shift could force individuals to rethink their long-term savings strategies, especially those who prefer the low-risk nature of cash ISAs.
The Potential Change to Cash ISA Rules
Under current regulations, Britons can deposit up to £20,000 per year across various ISA types, including cash ISAs.
However, rumors suggest that the government is considering slashing the cash ISA allowance, in a bid to encourage more people to invest in stocks and shares ISAs, rather than holding their savings in low-return cash ISAs.
This could result in many savers being forced to reallocate their savings into different assets.
What Is a Proxy ISA?
In response to these proposed changes, some experts suggest that savers could opt for ‘proxy’ versions of cash ISAs.
A proxy ISA would be a stocks and shares ISA that invests in cash-based assets, such as money market funds and short-term gilts, which mimic the characteristics of a cash ISA.
This strategy would allow savers to maintain the full £20,000 ISA allowance while still holding assets that behave similarly to cash.
How Proxy Accounts Work
Philip Dragoumis, a director at Thera Wealth Management, explains that it is possible to replicate the stability of a cash ISA with sterling money market funds, which hold deposits and very short-term government bonds.
This would work similarly to a traditional cash ISA but would fall under the stocks and shares ISA category, offering savers a way to navigate the new rules while maintaining low-risk investments.
Considerations and Challenges
While this workaround may help savers maintain their tax-free savings within the £20,000 limit, it comes with some considerations.
For instance, some savers may be hesitant to adopt a proxy ISA due to its potential complexity and exposure to market fluctuations. In addition, many investors unknowingly hold cash in their stocks and shares ISAs, which could reduce their long-term returns if not managed properly.
The Hidden Cost of Holding Cash In a Stocks and Shares ISA
James Norton from Vanguard Europe warns that holding cash in a stocks and shares ISA can erode overall returns, as stock market performance typically outstrips cash returns over time.
For example, assuming an investment return of 6% a year after fees for 20 years, a £20,000 ISA would grow to £64,000. However, if just one quarter of the ISA was held in cash earning 2% interest (a reasonable long-term rate), this would reduce the return by over 20%, bringing the total to around £53,000.
According to Vanguard’s analysis of around 500 UK investors’ portfolios, a quarter of these investors held more than 5% of their stocks and shares ISA in cash, with a third of these holding at least 50% of their portfolios in cash.
These statistics highlight the potential risk of maintaining too much cash in such accounts, which could limit long-term growth.
