What is an Isa and how might the rules change?

Chancellor Rachel Reeves has shelved any immediate changes to tax-free Individual Savings Accounts (Isas).

But the Treasury is still keen to encourage more investment in stocks and shares.

An Individual Savings Account (Isa) is a savings or investment product which is treated differently for tax purposes.

Isas are offered by a host of banks, building societies, investment companies and other financial providers.

Any returns you make from an Isa are tax-free, but there is a limit to how much money you can put in each year.

The current £20,000 annual allowance can be used in one account or spread across multiple Isa products as you wish.

These accounts do not close automatically at the end of the tax year. When the next tax year begins, you can open a new Isa or – in some cases – can keep adding money to your existing accounts.

You have to be 18 to open an Isa. You also have to live in the UK or be a member of the armed forces or a so-called Crown servant who works abroad.

Isas were first introduced by then-chancellor Gordon Brown in 1999, but the annual allowance and the way they work have changed several times since then.

Cash Isas are typically offered by banks or building societies, and function like a normal savings account.

Savers pay in money and interest gets added on top.

With regular saving accounts, once the interest goes above a certain threshold, you start to pay income tax.

A basic rate taxpayer can earn £1,000 in savings interest a year before paying tax. For higher rate taxpayer the limit is £500, but additional rate taxpayers don’t have any allowance – they pay tax on all their savings income. Those on low incomes may get an extra allowance.

However, when money is saved in a cash Isa, the interest is tax-free, no matter much you earn.

Cash Isas are very popular, with millions of savers holding billions of pounds in them.

Stocks and shares Isas work in much the same way.

However, instead of simply being held in an savings account, the money is invested in shares in companies, unit trusts, investment funds or bonds.

Unlike other investments, any returns are protected from income tax and capital gains tax.

Crucially, while the returns can be greater, so too are the risks. The amount of money you have in a shares Isa can go down as well as up.

Junior Isas allow young people to save – or let their parents save for them – until they reach 18 – when they can access regular Isas.

Lifetime Isas (Lisas) are designed to help people save towards a deposit when buying a first home, or for retirement. Savers can put in up to £4,000 a year and the government adds an extra 25%.

However, critics argue the rules about how they work are too strict, and some savers have fallen foul of property purchase price limits.

Innovative Finance Isas let people use other types of financial arrangements such as peer-to-peer loans, without going through a bank.

After intense media speculation, it is now understood that the chancellor will not be making any immediate changes to cash Isas.

However, the government says it wants to “ensure people’s hard-earned savings are delivering the best returns and driving more investment into the UK economy”.

Reeves will outline some of those plans at the annual Mansion House speech in the City of London on 15 July.

It is thought the government wants to encourage savers to put money into stocks and shares. This could potentially benefit British companies, and boost economic growth in the UK which has been sluggish.

Many investment companies that sell stocks and shares Isas back such a move, while banks and building societies who dominate the cash Isa market are more cautious.

Those in favour say there are billions of pounds languishing in savings accounts, which do not need to be accessed in a hurry.

They say that savers could benefit, as well as the wider economy, if that money is invested in stocks and shares in the long-term, rather than sitting in savings accounts.

They want reforms to encourage personal investing.

When the chancellor was considering reducing the attractiveness of cash Isas, opponents said there was little evidence that people would shift to stocks and shares Isas instead.

They warned many people might not save at all, or would simply pay more tax on any money held in non-Isa accounts.

Building societies, in particular, pointed out it would also reduce the amount of money they received from savers’ deposits which could then be lent out as mortgages or other loans.

As a result, the cost of borrowing could rise.