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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello, and welcome to our latest On The Money podcast, a weekly show that aims to help you make the most out of your savings and investments. So today, we're gonna cover how ISAs are gonna change from the start of the next tax year, which is the 04/06/2027. And joining me to help tackle this topic is Craig Rickman, who is personal finance editor at Interactive Investor. Craig, thanks for coming on.
Craig Rickman:Thank you very much for having me, Kyle.
Kyle Caldwell:So, Craig, some of the rule changes to ISAs were already known. However, there was a big announcement last week, which is that there will be a new flat rate charge of 22% on interest paid on cash within a stocks and shares ISA or an innovative finance ISA. Could you firstly explain why that's been introduced and why it's part of the government's efforts to try and turn us into a greater nation of investors?
Craig Rickman:Yeah. Sure. So let's go back to the autumn budget 2025. Chancellor Rachel Reeves announced that the amount that you could put into cash ices every year, if you're 65, would drop from £20,000 a year to £12,000 a year from the 04/06/2027. And what's sort of underpinning or underpin that change is, as you say, this desire to foster a retail investing culture in The UK.
Craig Rickman:The government was concerned that people were keeping sort of long term wealth in cash, and that was sort of more prone to to the effects of inflation and wouldn't wasn't growing as quickly as it could if it was invested. So what they've decided to do is shrink the cash ISA allowance, which means that if you want to use your full stocks and shares ISA allowance every year or sorry, use your full ISA allowance every year, you would have to put at least £8,000 into stocks and shares again if you're under age 65. But what the government is concerned about and flagged sort of a few weeks after announcing that change was that people could get around the rules. They could circumvent them. They could they could game the system by investing in cash or cash like assets within a stocks and shares ISA.
Craig Rickman:So they're effectively still investing in cash, which isn't sort of helping the government's aim to foster retail investing culture. We should add as well that this is that's not the only aim of this. It's also to try and boost The UK economy as well. But, anyway, the government is concerned, and that's been the big announcement this week of these, yeah, these rules to try and sort of prevent, deter people from using cash or cash like assets within a stocks and shares ISA and invest the money instead.
Kyle Caldwell:However, there is good news for investors in money market funds. So these funds, they own a diversified basket of low risk bonds, high quality bonds that have short lifespans, typically a couple of months. And, typically, the level of income that is generated by these funds with the underlying investments held within them is typically around about what UK interest rates are. So at the moment, you can get a yield on a money market funds of 3.75%, typically. Now there were fears that money market funds would be caught up in this.
Kyle Caldwell:And if there was to be a tax imposed on cash in a stock and shares, as you say, that money market funds will be a part of that. However, the rules that came out last week indicate that you can still invest in a money market fund, provided that you don't own a 100% of those funds in the stock and shares ISA. So the rules indicate that as it as as it is at the moment, there's gonna be no tax to pay on money market funds. Yes.
Craig Rickman:But I think that's where I mean, there there are there are several complications to these new rules. I mean, yes, good news on the surface that if you're not investing sort of a 100% of your portfolio in money market funds, that they are gonna fall outside of this sort of definition or that you're not gonna pay this 22% tax charge on any interest. But there there are various things about that this about these these rule changes that have made things made things pretty complicated and just mean that investors are gonna have to pay a bit more attention to what they're doing and who inevitably will pay more attention to what they're doing within their stocks and shares ISAs and how they're using various assets because they're gonna want to avoid paying a tax charge when they can, you know, when they don't have to.
Kyle Caldwell:So I'm just gonna read out what it said in the announcements, and you can look this off online. It's called ISA reform 2027 anti circumvention rules fact sheet. And what it says is cash like assets will be eligible for noncash ISAs provided that they are partial allocations and do not make up a 100% of the investments in an individual's noncash ISA accounts. From April 2027, cash like assets will be defined as money market funds only and will require ISA managers to report their market value via the established end of year statistical return. So my interpretation of this, which I know you share as well, Craig, and how it's been widely reported, is that you could in theory put 99% of a stock and shares ISA in the money market funds, and then 1% in any particular investments if you want to, and that would still be allowed under these rules.
Craig Rickman:Yep. Yep. That's my interpretation as well. So effectively, if you're under 65, you could put £12,000 in your cash ISA, 7,900 in money market funds, and then a £100 in a UK equity fund, and that's okay. There's no there wouldn't be any any tax to pay on the interest that you receive from your money market funds.
Craig Rickman:So interesting way of doing it.
Kyle Caldwell:I mean, as loopholes go, I mean, I think this is probably the easiest one I've ever seen Indeed. In my life for people that wanna try and exploit it. However, as we know with loopholes, if too many people do exploit them, then they do tend to be closed over time. And it did say in the announcement that a technical consultation with industry on the draft legislation will commence shortly and that the regulations will be laid in the autumn, and new rules will come into force from 04/06/2027. So time will tell.
Kyle Caldwell:You know, for all we know, there could be changes to the rules that were set out last week. But at the moment, as it stands, it does appear that you could put 99% if you wanted to into money market funds in your stocks and shares ISA. Now, in terms of the role of money market funds in a portfolio, a lot of investors do invest in them. And in the main, people view it as a temporary place to park some cash. For instance, you know, you might be a bit wary of, you know, stock markets being volatile over a short period, or you might be deciding where to invest next.
Kyle Caldwell:If not may and in the meantime, you're parking cash in the money market funds. But we also do see, you know, some people like to have a larger allocation to money market funds at certain points of their investment journey. For example, derisking a portfolio ahead of retirement. And also, if you're quite close to to hitting a specific goal. For example, if you've been investing in trying on the property ladder and you're quite close, actually think I don't want to subject my investments and the returns I've made to, you know, the volatility that is natural part of investing.
Kyle Caldwell:And instead, I'll I'll play it safer, and I'll put it into a money market fund.
Craig Rickman:Absolutely that, yeah. I mean, yeah, there can be reasons to either hold a, like you say, a portion of your portfolio or in some cases perhaps the whole lot if you need to use the full amount for a specific purpose. It's essentially any situation where you are you you have no capacity for loss, where you can't afford for the value of that money to fall because that could jeopardize the goal that you've been saving or investing for. So, yeah, they're a very natural and sensible sort of feature and asset class for, you know, for investors of all stripes to use within their their ISO portfolios.
Kyle Caldwell:And at the moment, given where UK interest rates are, you know, money market funds, they are offering inflation beating income at the moment. However, that's not always the case. You know, I caution the, you know, if you invest in money market funds when interest rates were at rock bottom levels, that was that was not an attractive place to be at all. And in the future, you know, you know, we don't know where UK interest rates will be in five or ten years' time. But if they are a lot lower than they are today, then the returns, the perspective returns on money market funds will then be lower as well.
Kyle Caldwell:So I think it's but I do think, you know, I think, you know, I think investors do generally understand money market funds, and they know that they're not something to simply buy and hold for the long term. And also, if you put too much of a portfolio into them, then that can come at the expense of capital growth over the long term, because you're not investing in a growth producing asset such as what a global index fund or a global equity fund will give you.
Craig Rickman:Absolutely that. Yeah. Yeah. I mean, successful investor appreciates that any money held in cash or a cash like asset like money market funds, if they're held over a long period, then they're more vulnerable to the corrosive effects of inflation. So that's that's fairly well understood and I think that the, you know, this idea that people will just use cash and cash like assets within their ISA if they're under 65.
Craig Rickman:Yeah. I'm not sure that that will will come to pass. Of course, that's an option for people, but I think the vast majority who do have the ability to fill up their ISA every year, and I think a lot of the research shows as well that they tend to invest it.
Kyle Caldwell:Completely agree. I think it's a potential useful component as part of a well diversified portfolio. Going back to the 22% tax on cash within the stock and shares ISA, Craig, could you explain how the government's arrived at coming up with it being 22%?
Craig Rickman:Sure. Yeah. It sounds like a bit of an arbitrary figure, doesn't it? The 22% represents the basic rate that you will pay or basic rate of tax that you will pay on savings interest from the next tax year. So the tax year when these ISO reforms kick in.
Craig Rickman:So the tax on on savings rates are increasing by two percentage points across the board from the basic, higher and additional rate. The basic rate will be 22%, so that's how the that's how the government has got to that figure.
Kyle Caldwell:In terms of other potential question marks and potential implications of tax and cash within a stock and shares, used to a couple I thought of included the fact that, you know, whenever you sell any investments, then the proceeds go into cash. And some investors will automatically well, not automatically. Some investors will straight away know what to invest in, but others might wanna take the time a bit more. So does that mean that depends on how long you've put the money in cash for the interest you've then earned over that period is that you're then gonna be taxed on that. It looks like that anyway.
Kyle Caldwell:And also, some people, you know, towards the end of the tax year, some people like, okay. I can put x amount in to make use of the ISO allowance that year before tax year ends, but they haven't decided what to invest in. So then they temporarily park some cash, and then decide at a later date what to invest in. So is that then gonna impact those people? Are they then going to be taxed on that?
Kyle Caldwell:I just worry that this tax will punish prudent investors.
Craig Rickman:Yes. I think that I mean, there are a few problems that have been raised with this, with this, you know, these reforms, and that's that's one of them that people doing very sensible and making sensible and natural decisions within their portfolio, you know, using cash could end up paying tax. And it just it creates this rather confusing mess of ISAs and how they work. You know, for well, for the past, at least the past ten years, you know, providers have been able to market them and say you paid no tax on capital gains, no tax on dividends, no tax on interest. Before 2016, interestingly, you did pay a bit of tax on the dividends.
Craig Rickman:There was a there was a 10% tax credit that was charged and providers couldn't reclaim it. That was removed as part of a big overhaul to the dividend tax regime. But for ten years, yeah, you you you haven't paid tax on dividends. But how is that gonna be communicated now is that you you there's no tax on interest? Maybe, but you you could pay tax on interest like we've like we've been speaking about.
Craig Rickman:So it just makes things very, very confusing, you know. In addition, you can't if you're under age 65, you can't transfer from a stocks and shares ISA to a cash ISA, but if you're over 65, you can. So there's there's a quite a lot of rules. There are quite a lot of rules for people to, you know, grasp, and also to be aware of how they can change over time without any further policy changes, you know, just that they can the rules can change once you hit a certain age, who's 65.
Kyle Caldwell:Yeah, for me, I think it's a real shame that Icers are no longer as straightforward as they once were. And I do think if you put barriers up, it will put people off ultimately. I think if you're trying to convince someone to invest for the first time, you know, I think it's a lot easier if you can say, look, this is great product. It's it's called a tax efficient ISA where, you know, you don't pay any tax on any gains that you make or interest you earn. But obviously, from next April, you can no longer say that because there will be the tax on cash within the stocks and shares ISA.
Craig Rickman:Well, yeah, you could have a scenario where you're paying tax in the tax wrapper and you're not paying tax outside the tax wrapper. So for example, you could have, you know, I had to say you held a 100 money market funds, so you get penalized. So any interest that you receive is taxed, then you've got money outside of your ISA, but that interest is covered by your annual savings allowance, the amount that you can earn every year in interest tax free, which the base rate taxpayer is a thousand pounds, for a higher rate taxpayer is £500. If you're an additional rate taxpayer, you don't get a savings allowance. So it's quite possible that you could have that situation where you've got we've you know, you promote a tax wrapper, grow your money tax free and receive your interest tax free, but in fact, you could end up paying more tax than if you'd held the money outside of the tax wrapper because the savings allowance I have to keep sort of keep following me with this.
Craig Rickman:The savings allowance can't be used within the ISA wrapper. So, I mean, that's that's a very that's that's a tricky thing for people to understand and sort of, you know, going back to the point you made around it sort of being more complicated, that's, you know, could could that put people off investing in an ISA? Could that, you know, investing in a in a stocks and shares ISA? Because they're not clear on the amount of tax that they might pay. They might think, well, do know what?
Craig Rickman:I'm gonna I'm gonna keep saving because I know how it works.
Kyle Caldwell:Just going back to the comment you made about money market funds, if got a 100% in them, that you may get taxed. We don't actually know whether that's gonna apply at the moment. We don't know whether it's like an outright ban that you can't invest in them if you've got a 100% or if they will be then taxed if you do. So, but I mean, for me, this just makes it all confusing, and I think the sooner we can get clarity on what these new rules are gonna be, the better, you know, and it'll give investors more time to actually plan accordingly.
Craig Rickman:Absolutely. Yeah. And I think that's it. There's a lot of confusion about exactly how this will work. I mean, we've only seen the details for a few days and had a bit of time to digest them.
Craig Rickman:There wasn't lots and lots of information in there. I guess there didn't need to be. But, yeah, there there has been a bit of confusion confusion around the interpretation of these rules.
Kyle Caldwell:So we have multiple ISAs, different rules, depending on your age, whether you're 65 or 65. And we also now have the cash part of a stock and shares ISA facing a 22% tax charge. So, Craig, how do we then make the ISA system even more complicated?
Craig Rickman:Of course. Sounds like the setup to a joke.
Kyle Caldwell:Well, it's actually the setup to the final part of this podcast. Alright. So the way you make it more complicated is you create a new ISA, and that's what the government is considering doing. And this is for first time buyers on the property market. So could you explain what the shape and form of this new ISA may be?
Craig Rickman:Sure. Yeah. It's it's probably best to first talk about what this ISA is effectively replacing. So something called the lifetime ISA, which has a dual purpose. So you can use the money to buy your first home.
Craig Rickman:If you don't use the money to buy your first home, you can use the money for your retirement or you can access it at age 60 more specifically. The government recently said that they're going to look to overhaul the product and replace it, and now we've got a bit more information about what's going to replace it. So to try and keep this fairly succinct, this is called a first time buyer ISA. So as you can probably tell, the retirement savings element of the LISA, that is being sort of put to one side, and this is purely for buying a first home. To be honest, the further information on this is really, really light.
Craig Rickman:We don't know what the subscription limits are gonna be, just to go back to the lifetime ISA. The sort of big benefit with it is that you get a bonus on what you put in. So you can put in up to £4,000 a year, you get a 25% bonus. That's the sort of big carrot with it. But for this new product, we don't know how that's gonna work.
Craig Rickman:We don't know what the maximum property value will be. That's been a real sticking point with the lifetime ISA. It's 450,000 has remained that way for a long time, and that's apparently caused problems for lots of lots of buyers who wanted to use the product or use the LICA to buy a home. So we we we don't know sort of those elements of it. There's some other things we don't know as well.
Craig Rickman:There's a consultation running. They've said that it will be announced or the details of the products will be announced at a future fiscal event. So the earliest that we will find out more about this will be this year's autumn budget, which will be held in October or November.
Kyle Caldwell:So, Craig, I think we've covered off all the bases for now on the information that we have available to these ISA changes, some of which are gonna take effect from April 2027. Thanks for coming on.
Craig Rickman:Thank you very much for having me.
Kyle Caldwell:And that's it for our latest episode of our On The Money podcast. Hope you've enjoyed it. We love to hear from listeners. And if you have a question that you would like on the team to tackle, then please do get in touch. And the way to do so is by emailing otm@ii.co.uk.
Kyle Caldwell:In the meantime, you can find plenty of analysis related to personal finance and investments on the Interactive Investor website, which is ii.co.uk. And I'll hopefully see you again next Thursday.