How to guard your Isa in case Labour launches a tax raid

As Rachel Reeves is given the keys to ­Dorneywood, the 21-room grace-and-favour Buckinghamshire home that was occupied by Deputy Prime Minister John Prescott in the last Labour government, it is perhaps the strongest signal yet that the Exchequer’s ­responsibility surpasses that of Deputy Prime Minister, Angela Rayner.

Reeves is set to follow through with Sir Keir Starmer’s ­warning that those with the ‘broadest shoulders’ will bear the brunt of tax hikes in her first Budget next month.

Left-leaning think tanks have been advising Reeves to loot pension savings and take a hefty chunk out of our children’s inheritances. And experts say that Individual Savings Accounts (Isas) could also be in the Exchequer’s sights.

Here we reveal how the Chancellor could raid Isas – and what you need to do NOW to protect your nest egg.

Why could Isas be in Reeves’s sights?

Isas allow you to save or invest up to £20,000 a year without having to hand over a penny of tax on the interest, returns or capital gains earned.

Offering such generous tax breaks does not come cheap.

The Resolution Foundation estimates the tax relief offered through Isas will ‘cost’ the Treasury a hefty £6.7 billion in 2023-24 in taxes they might otherwise have collected, up from £4.9billion in 2022-23.

The rise is largely thanks to higher savings rates.

There is now just shy of £750 billion sitting in cash and stocks and shares Isas in the UK, with more than 22 million adults holding some of their savings in the tax-free accounts, according to Government figures.

Isas are available to everyone of all incomes and levels of wealth. However, a small minority of people with significant wealth are able to take most advantage and shield large sums from tax.

Labour may look at this cohort and question whether the State really has to offer the ­current level of tax breaks to encourage them to save.

The signs of a ­government eyeing up tax-free savings are ominous.

Labour already scrapped plans earlier this month that would have allowed savers to put another £5,000 into a British Isa ­investing solely in UK companies.

This was a ­Conservative policy outlined before the election was called.

‘There were almost four million people with Isas valued over £50,000 in 2020/21,’ says Sean McCann, chartered financial ­planner at NFU Mutual.

‘The Government could choose to limit the amount that ­individuals can hold in Isas or reduce the £20,000 annual Isa allowance to bring that cost down.’

How could Isas be watered down?

Economists at the Resolution Foundation have called for an individual Isa cap of £100,000. Anyone who hit this level would no longer be able to add to their Isas.

Alternatively, the £20,000 annual limit could be reduced – and the Government might argue that only the wealthiest savers would be impacted. The Resolution ­Foundation says that £20,000 is over four times the median level of total savings – including current accounts and other savings products – per adult.

On average, adults have around £4,700 in cash savings, according to this measure.

Alternatively, the current £20,000 limit could be left at the same level for years to come, with its value gradually being eroded by inflation.

The limit has already been kept at £20,000 for seven years since 2017. Had it increased with ­inflation, it would now be above £25,000.

How likely are changes to Isas?

Ed Monk, associate director of Fidelity International, doesn’t expect sweeping changes to the Isa rules next month.

Isas are well-loved financial ­products and used by most households to help boost their savings. Making them less value would in effect deter saving.

However, experts suggest that other tax tinkering in the Budget could make Isas even more attractive.

For example, if Chancellor Rachel Reeves puts up capital gains tax rates in the Budget, then being able to invest without attracting the tax becomes more valuable.

‘Were the tax treatment on ­pensions to change this might also reduce individuals’ scope for tax-efficient long-term saving,’ adds Monk.

‘Changes in either area would only add to the importance of maximising the Isa allowance if you can.’ It could also make Isas a more likely target in future Budgets if their ­popularity soared.

Isas to shield Budget changes

It’s unlikely that money saved into Isas would be taxed ­retrospectively. That means it makes sense to maximise the accounts now.

You can save the £20,000 annual allowance into a cash Isa, stocks and shares Isa or innovative finance Isa, or split the allowance across multiple accounts, which could include saving up to a maximum of £4,000 into a Lifetime Isa.

Saving into a cash Isa means you don’t have to declare any interest you earn to HMRC as there’s no tax to pay on that income.

Capital gains and dividend income earned in a stocks and shares Isa are not subject to tax, and again don’t need to be declared to the taxman.

The same rules apply for ­innovative finance Isas, which allow you to invest your savings into a wider range of assets ­including peer-to-peer loans, crowdfunding debentures (company debts) and alternative funds.

These investments tend to be higher risk but with a higher reward potential. The rules for Lifetime Isas are slightly different, though all income and gains are still tax-free.

You can open a Lifetime Isa if you’re between 18 and 40 and you can put in up to £4,000 a year until you’re 50.

For every £1 you pay in the Government will add 25p as a top-up (or 25 pc), meaning you can get up to £1,000 free each year.

You can only keep the bonuses if you use the money you save to buy your first home or to fund your retirement later in life.

Rosie Hooper, chartered ­financial planner at Quilter ­Cheviot, warns: ‘Your Isa ­allowance resets each tax year and it is a case of ‘use it or lose it’ as it does not carry forward into the next tax year.

‘While not everyone will be able to save the full £20,000, it is important not to overlook it as it offers an excellent opportunity to grow your money free of tax.’

Be split-savvy

Isa rules changed on April 6, 2024, meaning you can now split your £20,000 Isa allowance between multiple cash and investment Isas in the same tax year.

Ed Monk says: ‘This means investors can spread their investments over different providers.

‘For example, if you wanted one stocks and shares Isa for longer-term investments and a separate Isa for more regular trades you’ve got this level of flexibility.’

But, he warns, it can be easier to keep track of your investments and possibly cheaper, too, if you consolidate them into one.

Monk also suggests using the ‘Bed and Isa’ rules.

These allow you to sell investments in a taxable account and repurchase them in an Isa, potentially shielding them from a capital gains tax hike in the Budget.

‘This process is handled by your investing platform so it’s worth building in time to organise a transfer,’ he adds.

How IHT changes might affect Isas

Any funds you’ve saved in an Isa will form part of your estate when you die and are therefore liable for inheritance tax.

However, your beneficiaries can inherit an additional allowance so they can keep your tax-free savings in their own Isa. This is known as an Additional Permitted Subscription (APS) and it becomes available to beneficiaries when probate is granted.

For example, an Isa valued at £60,000 can be left to anyone the deceased chooses but their ­surviving spouse or civil partner is entitled to invest up to that value into their own Isa in addition to their personal £20,000 annual Isa allowance, the following year, without paying any tax. 

‘If you leave them the money, effectively this means your spouse can inherit your Isa savings without losing the tax advantages,’ says Rosie Hooper.

Kevin Brown, savings expert at Scottish Friendly Society, says: ‘There has been much talk of an inheritance tax (IHT) ­clampdown coming in the Budget, particularly around the exemptions that pension savings currently enjoy.

‘While Isas don’t actively mitigate IHT to the same degree, the removal of such a perk from pensions could enhance the Isa’s appeal as an alternative.’

How families save £67,000 tax-free 

Children are also entitled to save up to £9,000 tax-free each year, with parents pouring £1.5billion into cash and stocks and shares Junior Isas in 2021/22.

Kevin Brown says: ‘Though Junior Isa rules prohibit ­grandparents and other family members from opening one directly, leaving it to the parent or guardian to do so first, once open other family members can contribute.’

For a family with two parents and three children under 18, this means being able to tuck away up to £67,000 a year across a number of Isa accounts – none of which is subject to any tax.

Time to invest

Cash and investments offer ­different advantages and risks, says Ed Monk.

Cash is not vulnerable to losses in the way that investments are. Investments, on the other hand, can lose value but historically have offered higher net returns over long periods.

For those with a higher risk ­tolerance, investing in the ­Alternative Investment Market (AIM) through a stocks and shares Isa could be worth considering, says Rosie Hooper.

‘AIM Isas allow you to invest in smaller, growing companies and under current rules, shares held in these companies may qualify for business property relief,’ she says.

‘This can make them exempt from inheritance tax if held for at least two years.’

But she cautions: ‘The Government could alter or remove these tax benefits in future Budgets, which could impact the effectiveness of this strategy.’