Three problems with taxing cash inside investment ISAs

Meddling with rules around individual savings accounts (ISA) will always attract controversy.

ISAs hold a special place in the heart of UK savers and investors, who ploughed a record £103 billion into the tax wrapper during the 2023-24 tax year alone.

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The main draw with ISAs is simple: you don’t pay tax on investment gains, dividends and interest, helping the pot to grow faster and your income go further.

But some of the tax advantages are soon set to be watered down.

According to an article publishedlast Friday in The Telegraph, from April 2027 cash held within a stocks & shares or innovative finance ISA will face a tax charge of 22% - aligned with the basic rate applied to savings interest from the start of the next tax year. 

The tax is also set to be levied on cash-like investments such as money market funds, which are finding favour with investors seeking to earn decent interest with minimal risk.

No confirmation…yet

While the government is yet to confirm or deny these rumours, they haven’t come as a huge surprise. In December 2025, policymakers laid out plans to “charge on any interest paid on cash” held in investment ISAs, as part of a broader push to channel more money into the stock market to improve saver returns and stimulate the UK economy.

With the amount that under-65s can save annually into the cash version dropping from £20,000 to £12,000 from the 2027-28 tax year, the government wants to prevent cautious savers craving tax-free interest from circumventing the rules and maxing out their allowance by ploughing £8,000 into cash-like assets held within a stocks & shares ISA wrapper.

But big question marks hang over whether this is the right approach. Aside from the administrative headache it may create for providers, there are several reasons why taxing cash within investments ISAs could do more harm than good.

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1) It’s a backwards step

In 2014, then-Chancellor George Osborne announced a radical shake-up to the ISA regime. Osborne equalised ISA allowances across the board (prior to this the cash limit was lower), raised the allowance from £11,520 to £15,000, enabled people to move freely between the stocks & shares and cash types, and removed the 20% tax on interest paid within investment ISAs.

The former chancellor’s measures were warmly received, bringing much needed consistency, simplicity and cohesion to the ISA system. But much of this progress will shortly be undone. The facility to switch between ISA types will be removed from April – once again to stop savers with more than £12,000 from swerving the cash ISA cut.

In a retrograde move, we’re edging back to an outmoded framework, one that runs counter to the government’s pre-election pledge to simplify ISAs.

Since 2014, we’ve seen other positive changes to ISA taxation.

Between 2004 and 2016, ISA managers weren’t permitted to reclaim the 10% “notional” tax credit paid on dividends, meaning for every £100 of dividend income investors received, HMRC grabbed £10. This, however, was scrapped as part of an overhaul to the dividend tax regime. ISA investors now keep the full dividend payment.

It may not sound a huge percentage, but over time what can appear a modest tax charge on income payments can nibble away at your wealth, reducing how much goes into your bank account or is rolled into your fund to compound over time.

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2) Savvy investors could be penalised

Experienced investors are keenly aware of the risks presented by stashing money in cash over extended time periods. They equally appreciate the role of low growth but secure assets in any well-rounded portfolio, helping protect against volatility.

For evidence of this, we can turn to interactive investor data for another tax wrapper - self-invested personal pensions (SIPP). The results from our quarterly index regularly show that investors, both those accumulating funds and in drawdown, keep around 10% of their pension in cash, and that excludes money market funds. It’s not for me to comment on whether individual investors are holding too much or too little in this asset, but the data shows it serves a crucial function.

Events in the past couple of years help to illustrate instances where security might be favoured. A few months ago, with tax year end 2025/26 fast approaching, markets swung wildly in response to events in the Middle East. And roughly 12 months before, US President Donald Trump’s trade tariffs triggered similarly volatile fluctuations, spooking investors who may have naturally feared a sharp downturn might follow.

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Taxpayers needing to max out their ISA allowance either before or after 5 April may have opted for money market funds until the nerves have settled. From next April, sensible strategies such as this could come with a tax charge.

Those who need to derisk some or all their ISA investments may also be punished under the speculated reforms. For instance, if you plan to use your stocks & shares ISA pot to buy a home in the next one to two years, divesting into cash in fear that a market crash will derail your home ownership plans, is a savvy tactic.

When switching to a cash ISA is no longer be allowed, unless you withdraw the funds to your savings account and future interest is covered by your personal savings allowance, you’ll inevitably pay a tax charge on future returns.

3) There’s no guarantee it will help achieve the government’s aim

The government’s bid to turn millions of savers into investors is a laudable pursuit, and one that could indeed improve the nation’s financial security.

Consumers who’ve doggedly stuck with cash over the past five, 10 or 20 years will have significantly less wealth than if they’d funnelled even some of those savings into the stock market. While the past is, of course, no guide to the future, historical data suggests investing offers a much better chance than cash of beating inflation, and the odds increase over longer time frames.

But this message is yet to reach the ears of millions of savers. And, as such, hopes that the upcoming cash ISA reforms will transform the nation’s low propensity for investing might be misplaced. Those wary about investing in the stock market might choose to take the tax hit inside the stocks & shares ISA wrapper or plump for taxable savings accounts.

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The government may argue its collective investing campaign - alongside changing the narrative around risk warnings and its “Savvy Squirrel” initiative - will ultimately shift the dial, rather than restricting tax perks on cash held in ISAs in isolation. Yet there’s no guarantee it will have the desired effect.

In contrast, there’s a risk the opposite could happen. Making the tax regime within investment ISAs more complicated could cause heads to remain buried in the sand, deterring rather than attracting a new wave of investors.