Rachel Reeves’ parting shot as chancellor is to tax individual savings accounts (ISAs) for the first time.

From next April, those holding cash in their stocks and shares Isas will face a 22% tax charge on the interest received.

Industry sources have warned that the tax will undermine the tax-efficiency of Isas and add to an already complex set of rules.

In her November budget the chancellor slashed the annual Isa allowance from £20,000 to £12,000 for under-65s from April 2027. 

The amount that can be put in an investment Isa will remain at £20,000 in each tax year, in a bid to push more savers to invest in the stock market.

However, savers who hold cash in a stocks and shares Isa will have to pay the new tax on any interest they earn.

This will affect savers who hold uninvested cash in their account while deciding which stocks to buy or during periods of market volatility.

The chancellor’s new tax charge is designed to stop savers flouting the new £12,000 cash Isa cap by placing all of the remaining £8,000 allowance in cash inside an investment Isa.  Under current rules, this money would earn a high level of interest free of tax.

Critics say the new tax will reduce appetite for investing in Isas. Jason Hollands, a managing director at investment platform BestInvest, says: “This undermines the tax-free promise of Isas. It’s like using a sledgehammer to crack a walnut.”

Lifetime ISA to be scrapped

The government has also launched a consultation on the implementation of a new First Time Buyer ISA (FTB ISA) to replace the Lifetime ISA (LISA).

Rebecca William, financial planning divisional lead at Rathbones, said it “could mark a welcome shift towards simplicity in a space that has often felt unnecessarily complicated.”

The Lifetime ISA tried to serve two masters – helping people save for a home and for retirement – and in doing so it often created confusion rather than clarity, said Ms William.

“A more focused product that is solely geared towards getting on the housing ladder should be easier to understand and use in practice, particularly as it removes the withdrawal penalty that proved so contentious with the LISA.

“However, this comes at the expense of the Lifetime ISA, which did offer under‑40s another tax‑efficient route to build savings for later life.

“One of its key advantages was that withdrawals from age 60 are completely tax free – a notable contrast to pensions, where typically only 25% can be taken tax-free. Yet from our experience, the product often flew under the radar and was poorly understood by many savers.”

Rachel Vahey, head of public policy at AJ Bell, said: “Today’s consultation gives us the broad shape of the new ‘First Time Buyer ISA,’ but leaves us guessing on some of the most important aspects.

“Without detail on the level of government bonus, subscription limits or property price cap, it is difficult to judge whether this new product will be a meaningful improvement for aspiring homeowners.

“Since its launch in 2017, the Lifetime ISA has helped thousands of young people take their first step onto the property ladder. But the product has never been perfect, and the withdrawal charge has caused real problems for savers who need to access their money for any reason other than buying a qualifying first home or reaching age 60.

“Moving away from an upfront bonus should make the system simpler. Paying the bonus only when someone buys their first home removes the need to claw money back through a withdrawal charge if the savings are used in a different way.

“But this simplicity comes at a cost. Savers will lose out on the investment growth they could have earned on the bonus while building up their deposit. For some first-time buyers, that could mean having less money available when they come to purchase a home.”

The Treasury will not allow current Lifetime ISA holders to transfer to the new FTB ISA. But both products will be allowed to be used towards the same purchase.

“This leaves Lifetime ISA holders potentially juggling two products ahead of their life-changing purchase,” says Ms Vahey.

“The Treasury has been strikingly quiet on what this means for self-employed people saving for later life. Those who already have a Lifetime ISA will be able to keep saving, but that does nothing for the thousands of self-employed workers and others without access to a workplace pension who may need a flexible retirement savings option in future.”

How will the new FTB ISA work?

The proposed new FTB ISA will be designed to help people save towards buying their first home. It can only be used where the home is bought with a mortgage.

Savers will receive a government bonus when they use the money to buy their first home. The bonus will be based on how much they have paid in, less any withdrawals, not on any investment growth. There will be no upper age limit, so people will never be too old to open or keep one.

But the government has not yet confirmed some key details, including how much people will be able to pay in each year, the maximum property price that will qualify, or how generous the bonus will be.

The new ISA will sit within the wider ISA rules. For example, money paid into the cash version of the FTB ISA will count towards the overall ISA allowance, and for under-65s the annual Cash ISA limit of £12,000 as well.

The government also plans to apply anti-avoidance rules to stop people using the new ISA in ways it was not intended. That will mean a 22% charge on interest paid on cash held in the investment version of the FTB ISA, and not allowing 100% of the investment portfolio to be held in money market funds.

People will also not be able to transfer money between a Lifetime ISA and FTB ISA. However, they will be able to use money from both accounts towards the same first home purchase.

Transfers from a Stocks and Shares FTB ISA into a Cash FTB ISA will not be allowed either, whereas transfers from a Cash FTB ISA into a Stocks and Shares FTB ISA will be allowed. This puts it in line with intended rules published today regarding anti-circumvention of the new Cash ISA regime from April 2027.

Savers will also be able to transfer money from FTB ISAs into a normal Stocks and Shares ISA, but not into a normal Cash ISA.