Isa savers to pay additional £605m a 12 months ‘stealth tax’ after allowance freeze

Savers will be paying £605million a year in extra tax by 2029 due to the Government freezing how much can be put into Isas.

Government rules allow savers to put £20,000 a year into Isas, £9,000 into Junior Isas and Child Trust Funds and £4,000 into Lifetime Isas. 

Any money this cash earns in interest is not taxed, unlike most other savings deals.

These limits remained frozen in the recent Budget, meaning that savers with these deals will end up paying £605million a year in extra interest by 2029/30, according to Government figures.

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The extra tax happens because once someone has topped out their Isas with £20,000, they start to pay tax on any interest they make, with the same principle applying at £9,000 for Junior Isas and Child Trust Funds.

The reason more savers will pay tax overall by 2029/30 is that the value of £20,000 now will be worth considerably less due to inflation.

As the value of money decreases, more savers will find themselves filling up their Isas quicker and then facing a tax bill. This will affect richer savers who can put more of their money aside.

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Basic-rate taxpayers can earn £1,000 in interest before paying tax – the level of the Personal Savings Allowance (PSA).

Higher-rate taxpayers can earn £500 before paying tax, while additional-rate taxpayers have no PSA at all, so are taxed on any savings interest held outside an Isa.

Basic-rate taxpayers pay  tax of 20 per cent on savings interest earned outside an Isa and certain other savings deals, such as NS&I Premium Bonds. For higher-rate taxpayers, it’s 40 per cent, while additional-rate taxpayers pay 45 per cent.

For example, a basic-rate taxpayer earning £2,500 interest on savings outside an Isa would pay 20 per cent tax on £1,500 for a bill of £300.

A higher-rate taxpayer in the same position would have a bill of £800, as their PSA drops to £500 and they pay 40 per cent tax on £2,000.

An additional-rate taxpayer in this hypothetical example would have a savings tax bill of £1,125, as they have no PSA and pay a 45 per cent rate on all savings interest held outside Isas.

Bestinvest personal finance analyst Alice Haine said: ‘Freezing the annual subscription limit at £20,000 for a further six years, alongside similar freezes on Junior Isas and Child Trust Funds – until the end of the 2029-2030 tax year – is expected to raise £605million for the Government’s coffers.

‘Had the Isa allowance been uprated in line with inflation since 2017 – the last time it was increased – it would sit above the £26,000 mark this tax year. 

‘If the figure continued to be adjusted in line with inflation until 2030, using the OBR’s inflation forecasts it could potentially edge closer towards the £30,000 point by then.

‘Instead, by keeping the Isa allowance on hold, it is effectively an allowance cut in real terms as it does not keep pace with inflation. 

‘This means people can protect less of their money from tax if they are able to max out the allowance in full, making the Isa allowance freeze yet another stealth tax.’