Rachel Reeves is set to slash tax-free saving pots in her Budget.

In a major blow to millions of hard-working savers, the Chancellor will significantly cut the annual £20,000 cash Isa tax-free allowance to £12,000, it emerged on Monday.

Ms Reeves is expected to argue that the billions of pounds sitting in the savings accounts would generate better returns if it was invested in the riskier stock market.

But she was warned on Monday that the plan would punish savers while potentially causing mortgage rates to rise and lenders to pull deals.

The raid comes as the Chancellor scrambles to fill her fiscal black hole and fund a £15bn welfare handout, including plans to scrap the two-child benefit cap.

Ms Reeves had been mulling slashing the tax-free Isa allowance to £10,000, but settled on a slightly higher figure amid a backlash over the proposal.

She has also ditched plans for a ‘Brit Isa’ which would have tied a minimum allocation of 20 per cent to UK equities, according to the Financial Times, which first confirmed the Isa proposals.

Money Mail’s Hands Off Our Cash Isas campaign had urged Ms Reeves to avoid overhauling the Isa regime.

A ‘disappointed’ Robin Fieth, Chief Executive of the Building Society Association, told the Mail: ‘A cut to £12,000 will not encourage more people to invest but will add unnecessary complexity, particularly around ISA transfers, and risks damaging the overall ISA brand.

‘This may also deter people from saving and investing. The best way to build a culture of investing is on a strong culture of savings.

‘As cash savings, especially ISAs, are used to fund mortgages there is likely to be an impact on the number of mortgages which can be provided, and/or the rate charged. We are pleased that the reduction is not as great as was originally proposed as that would have had a much more negative impact.’

Tory shadow chancellor Sir Mel Stride accused Labour of launching a tax raid on savers.

He told the Mail: ‘Hardworking savers shouldn’t be facing a tax raid to fund Labour’s addiction to ever more welfare spending.

‘The Conservatives warned that tax rises were coming after Rachel Reeves lost control of the finances. Slashing the cash ISA allowance would hit millions of responsible people trying to build financial security – especially in uncertain times.

‘Labour should be backing savers, not making them pay for the Chancellor’s failures.’

Around 40 per cent of the £726 billion held in Isas is in cash rather than stocks and shares. The accounts were launched in 1999 and have become hugely popular.

Tom Selby, director of public policy at AJ Bell, an investment platform, warned that the changes would harden the barrier between cash and investments.

‘Rather than pursue a measured policy focused on long-term simplification of ISAs to make it easier for people to invest for the long-term, the chancellor instead looks set to slash the Cash ISA allowance which will add complexity to the market.

‘Labour said it was looking at simplification of ISAs before the general election – these proposals are the absolute polar opposite of that.

‘It is not clear at all how this will incentivise people to invest and will probably result in a hardening of the barriers between cash and investments.’

The average ISA subscription is around £6,000, and Government sources said the vast majority of people would continue to pay no tax on their savings.

Ministers are said to want to protect those who rely on cash the most, and are seeking to boost savings and the economy rather than force people to invest inappropriately.

The Treasury declined to comment on the Isa changes. 

Meanwhile, Ms Reeves appealed to Labour MPs to ‘stick together’ even if they dislike some measures in Wednesday’s Budget.

At a meeting of the Parliamentary Labour Party on Monday, she acknowledged that Budget leaks had been ‘incredibly destabilising’ but insisted the final package would be ‘fair’.

‘A budget involves choices,’ she said. ‘Choices are things that we do, and also things that we don’t do. I hope that you like every single measure, but you might not.

‘There might be 99 per cent or 95 per cent that you like, but 1 or 5 per cent that you don’t. The budget is a package. It’s not a pick and mix – you can’t say you like the cola bottles but you don’t like the fruit salads. It comes together as a whole.

‘Politics is a team sport. We have to stick together if we’re going to deliver the change, and get the second term that we want and should deserve.’