Savers are set to see the amount of money that can be put in an Individual Savings Account (ISA) in a single tax year fall from £7,000 to £5,000.
Cash ISAs have proved popular
The changes, from April 2006, will mean the maximum amount allowed in a mini cash ISA falls from £3,000 to £1,000.
The Treasury wants to simplify the ISA regime which has been accused of being complex and putting off small savers.
The financial industry will now be consulted over the changes and draft regulations are due out next spring.
ISAs were introduced in 1999 with the aim of encouraging people to save more towards their retirement.
Under ISA rules - originally intended to only run for the 1999/2000 tax year but then extended until 2006 - one person can invest up to a maximum of £7,000 in any tax year free of income and capital gains tax.
A maxi ISA allows investors to put up to £7,000 into shares, but it can also be broken down to allow up to £3,000 to go into cash savings and £1,000 into insurance.
A mini ISA enables investors to split up their money into three separate cash, share and insurance ISAs.
The limits are £3,000 in cash, £3,000 in shares and £1,000 in insurance.
ISA limits from 2006
Maxi ISA: £5,000 to be invested in either stocks or shares, medium-term stakeholder products, life insurance or collective investments
Mini ISA: £4,000 in stocks or shares or £1,000 in cash
However, since the introduction of ISAs consumer debt has risen far faster than the amount being put aside for retirement.
The government's recent review of long term saving - conducted by Ron Sandler - concluded that people find financial products too confusing and are daunted by industry jargon.
Reform of the ISA regime is seen by many as a key part of the drive to simplify the savings industry for consumers.
The proposal to cut the amount that can be paid into cash mini ISA has been attacked on the grounds that it is the most popular aspect of the current regime amongst low to middle income savers.
"Cash ISAs are a terrific product for the person in the street to invest in," Mark Hemmingway, a Halifax bank spokesman, told BBC News Online.
"For the government to reduce the tax free sum is a real disappointment."