Cash ISA alert: Pension savers face double hit as Rachel Reeves' tax-free allowance cut to slash retirement savings

Chancellor Rachel Reeves is reportedly planning to slash the annual Cash Isa allowance from £20,000 to just £4,000 in her upcoming Mansion House speech.

Financial planning experts warn that the move risks penalising cautious savers and creating unnecessary tax headaches for millions, particularly pensioners.

Henrietta Grimston, Financial Planner at Saltus explained reducing the Cash Isa allowance risks delivering a double hit to savers. The first blow, she explained, is that "reducing the allowance risks penalising these sensible savers, making it harder to build tax-efficient pots for the future."

She added: "As people approach retirement, or other significant milestones where they need to access capital quickly, this could create a bigger savings burden, with tax taking a greater bite out of any growth.

The second hit, Grimston warned, is that the change "also risks pushing individuals into more complex tax situations, where they may need to submit tax returns for the first time, adding administrative stress and potentially costly mistakes."

Together, these twin threats could erode the security and simplicity that cautious savers—especially those nearing retirement—rely on to manage their finances without worrying about market volatility or tax complications.

Henrietta Grimston, Financial Planner at Saltus, said: "Clients with large cash ISA holdings aren't typically chasing high returns, they are prioritising security, flexibility and peace of mind.

"For many, cash ISAs offer a simple and low-risk way to manage their savings without worrying about market volatility."

She warned the changes could push individuals into more complex tax situations, potentially requiring them to submit tax returns for the first time.

"This could also reduce the overall efficiency of their retirement savings plans, as less can be sheltered in a tax-free wrapper, meaning they may need to save more just to reach the same target," Grimston added.

Analysis by wealth management firm Quilter reveals that abolishing Cash ISAs entirely would impose substantial tax burdens on all savers.

Older savers face particularly severe consequences from the proposed changes, with data revealing stark generational disparities in ISA holdings.

Over-65s hold an average of £63,365 in ISAs, compared to just £9,477 for those aged 25 to 34, according to government figures from 2021 to 2022.

Jordan Clark, financial planner at Quilter, said: "Older savers, in particular, tend to hold significant amounts in cash Isas."

A Freedom of Information request revealed that in 2019, 5.8 million over-65s held ISAs, with 3.4 million holding exclusively Cash ISAs totalling £87 billion.

"Removing cash Isa tax breaks would come as a much greater shock to pensioners," Clark warned.

The 2021-22 data showed 3.8 million Cash ISA accounts were held by savers aged 65 and over, highlighting the product's popularity among retirees seeking secure savings options.

A basic-rate taxpayer holding £42,243 in a Cash ISA – the average amount for over-65s – would face an additional £2,080 in income tax over the next five years if the product were scrapped.

The impact escalates significantly for higher earners, with higher-rate taxpayers facing £4,160 in extra tax and additional-rate taxpayers losing £4,680 over the same period.

These calculations show how the proposed reforms would erode the value of savings accumulated over decades, with tax taking a considerable bite from interest earned on what many consider their financial safety net.

Experts have suggested the Government should focus reform efforts on other ISA products rather than penalising risk-averse savers.

Grimston highlighted the Lifetime ISA as an example of where changes could be more beneficial, noting the £450,000 property cap is "increasingly out of step with prices in London and the South East."

She criticised the LISA's early withdrawal penalty as "particularly harsh," explaining it reduces savers' own contributions as well as the government bonus, potentially leaving people losing over 6 per cent of their own money."

A positive move could be to make the LISA more flexible and better suited to the realities of people's lives as their circumstances evolve," Grimston said.

She called for a wider review of ISA rules, particularly for targeted products like the LISA and Innovative Finance ISA.