The UK government will introduce significant changes to Individual Savings Accounts (ISAs) from the 2027-28 tax year, altering how investors can hold cash within Stocks and Shares ISAs and reducing the amount many savers can deposit into Cash ISAs without losing tax advantages.

The measures, outlined by HM Revenue and Customs (HMRC), form part of a broader policy designed to encourage greater participation in investment markets while preventing investors from using Stocks and Shares ISAs to bypass new limits on tax-free cash savings.

Under the revised framework, the overall annual ISA subscription allowance will remain unchanged at £20,000 per adult. However, the way that allowance can be allocated between Cash ISAs and Stocks and Shares ISAs will change for most savers.

Beginning in April 2027, individuals under the age of 65 will be permitted to contribute a maximum of £12,000 each tax year into a Cash ISA. Any additional savings beyond that limit will need to be placed either in a taxable savings account or within a Stocks and Shares ISA if investors wish to remain inside the overall £20,000 ISA allowance.

Individuals aged 65 and over will continue to retain the existing ability to contribute the full £20,000 annual ISA allowance into Cash ISAs.

One of the most significant changes affects cash balances held inside Stocks and Shares ISAs. Currently, any interest earned on uninvested cash within these accounts is exempt from taxation, consistent with the wider tax-free treatment traditionally associated with ISA products.

Under the new HMRC rules, however, interest generated from cash held within the cash component of a Stocks and Shares ISA will become subject to a fixed 22% charge from April 2027.

The charge is intended to discourage investors from using Stocks and Shares ISAs primarily as cash savings vehicles following the introduction of the lower Cash ISA contribution limit.

The measure applies regardless of whether an investor has exceeded the new £12,000 Cash ISA contribution threshold. Even individuals who remain below that limit but temporarily hold cash inside a Stocks and Shares ISA will be subject to the 22% charge on interest earned from those cash balances.

The rules will apply equally to investors aged 65 and above despite their continued eligibility for the higher Cash ISA contribution limit.

Stocks and Shares ISAs commonly contain temporary cash balances as investors wait to purchase investments, switch between funds or receive proceeds from asset sales before reinvestment. Such cash holdings have traditionally formed a routine part of portfolio management without affecting the account’s tax-free status.

Claire Trott, Head of Advice at St. James’s Place, said holding cash within a Stocks and Shares ISA is often a normal feature of the investment process. Investors may temporarily retain cash while deciding where to invest, completing portfolio changes or awaiting settlement before reinvesting funds.

Another major reform concerns transfers between ISA products.

Current rules allow investors to transfer funds freely from a Stocks and Shares ISA into a Cash ISA while preserving their tax-efficient status. From April 2027, individuals under the age of 65 will no longer be permitted to transfer money from a Stocks and Shares ISA into a Cash ISA under the new regime.

HMRC’s objective is to prevent investors from depositing the full £20,000 annual allowance into a Stocks and Shares ISA before subsequently transferring the funds into a Cash ISA, thereby circumventing the new £12,000 contribution ceiling.

The government is also introducing restrictions on money market funds held within Stocks and Shares ISAs.

Money market funds are generally regarded as relatively low-risk investment products designed to generate returns comparable to cash deposits while investing in short-term debt instruments. They have become increasingly popular among investors seeking stability during periods of market uncertainty.

Under the revised rules, investors will no longer be permitted to allocate 100% of a Stocks and Shares ISA to money market funds. HMRC has indicated that while these investments will remain available within ISA portfolios, complete allocation to money market funds will no longer be permitted regardless of the investor’s age.

The reforms have also clarified how the new 22% charge interacts with the Personal Savings Allowance.

Under existing UK tax rules, basic-rate taxpayers can currently earn up to £1,000 in savings interest each year without paying tax, while higher-rate taxpayers receive a £500 annual Personal Savings Allowance.

HMRC has confirmed that investors will not be able to use those allowances to offset or eliminate the new 22% charge applied to interest earned on cash balances within Stocks and Shares ISAs.

Instead, the charge will be deducted and paid directly to HMRC by ISA providers. The rate has been fixed at 22% for all investors regardless of their individual income tax band.

For higher-rate taxpayers, this means the new charge remains below the rate they would otherwise pay on savings held outside an ISA. According to HMRC’s revised guidance, higher-rate taxpayers will pay 42% tax on interest earned outside ISA accounts from April 2027, making the fixed 22% ISA charge comparatively lower despite ending the tax-free treatment previously associated with ISA cash holdings.

Investors who currently maintain substantial cash balances within Stocks and Shares ISAs still have time to adjust before the new rules take effect.

Until the new regime begins, cash can continue to be transferred into a Cash ISA under existing regulations where permitted. After April 2027, investors seeking to avoid the new charge on cash interest will generally need either to withdraw surplus cash from the Stocks and Shares ISA or invest those balances in eligible investment products.

Despite the changes, Stocks and Shares ISAs will continue to provide tax-free returns on qualifying investments. Investors will remain able to hold diversified portfolios including company shares, investment funds, government bonds and a range of other eligible securities without paying tax on capital gains or investment income generated within the account. Money market funds will also remain available, provided they do not constitute the entire value of the portfolio under the revised HMRC rules.