Cash ISAs have become more rewarding in recent months as interest rates have risen. Should you save – or invest in a stocks and shares ISA instead?
How do ISAs work?
Let’s cover the basics first.
An ISA enables you to save or invest without paying tax on interest or returns.
Every tax year the government gives us a tax-free ISA allowance. This year it’s £20,000, and it’s up to you to decide whether to put your whole allowance into a cash ISA, a stocks and shares ISA, or split it across the different types.
While there are a few different ISAs available for adults in the UK, cash ISAs and stocks and shares ISAs are the most popular. At Nutmeg, we offer stocks and shares ISAs, where you can choose from one of our four investment styles and our investment team will manage it for you.
If you’re lucky enough to be between the ages of 18 to 39 and are looking to save or invest for your first home, or put money aside for your retirement, then it might be worth considering a Lifetime ISA. The Lifetime ISA has an annual allowance of £4,000, which is deducted from your overall £20,000 ISA allowance, and you can open one in cash or invest in stocks and shares.
The best bit is that the government adds a 25% bonus to any contributions to help you get towards you goal. However, please note that there is a penalty for withdrawing in circumstances other than buying your first home or retirement.
A Junior ISA can be opened by a parent or guardian on behalf of a child, and anyone can contribute to them. The annual JISA allowance is £9,000, and this is separate to your personal ISA annual allowance. Junior ISAs by nature tend to be a long-term investment. Provided you start investing when the child is young, you may be getting at least a 10-year plus time horizon as these funds can’t be accessed until the child’s 18th birthday.
Can I have a cash ISA and a stocks and shares ISA?
Yes, you can have more than one ISA, and yes, you can pay into a cash ISA and a stocks and shares ISA.
However, you can only open and contribute to one type of ISA each tax year.
This means that you can open and pay into a cash ISA and a stocks and shares ISA in the same year. Or you could open a cash ISA this year and continue contributing to a stocks and shares ISA you opened last year.
What you can’t do is open two cash ISAs and contribute to both or pay into two stocks and shares ISAs – one that you opened this year and another you opened in a previous year.
You can spread your £20,000 ISA allowance across your ISAs. For example: if you contributed £12,000 to your cash ISA, you would only have £8,000 left to invest in your stocks and shares ISA tax-free. This allowance doesn’t rollover from one year to the next – you have to use it within the tax year.
What’s the difference between a cash ISA and a stocks and shares ISA?
A cash ISA works a lot like a normal savings account, and most high street banks offer several types.
Instant access cash ISAs, for example, can be good if you have short-term goals or know you may need to access your savings. Fixed rate ISAs can offer more competitive rates but require you to leave your money for a set period and can charge you if you make an early withdrawal.
Cash ISAs pay a rate of interest, which is influenced by the Bank of England’s base rate. Recently, interest rates have risen from historic lows to almost 15-year highs to combat rising inflation. This means that for the first time in a long time savers can now be rewarded for keeping their cash in the bank.
A stocks and shares ISA, on the other hand, is very different to a standard bank account. With this type of ISA, you’re not saving money – you’re investing it. You can’t make withdrawals in the way that you would with a bank account or a cash ISA, but nor should you. Investing is designed to help money that you need over the long-term, of at least three years, retain or grow in value. That’s why your pension is invested – or you may use it to save for a deposit on a house. It’s for money that you’ll need in decades, not days.
As a stocks and shares ISA is an investment, the capital you put in isn’t protected from rises and falls in the value of the underlying assets. This means you can get back less than the amount you originally invested, so you need to make sure you’re comfortable with the risk before committing.
Why would I choose a cash ISA?
Generally speaking, cash is good for short-term savings.
If there’s a possibility you’ll need cash for an emergency, or you’re saving for a specific goal within the next few years, keeping your money in a cash ISA may be a good option.
Why would I choose a stocks and shares ISA?
A stocks and shares ISA can help you grow your money over the long-term. By long-term, we mean at least more than three years away.
So, if you’re planning for your future, want your money to retain its value, and understand there are risks associated with investing, you might want to invest in a stocks and shares ISA.
Should I have a cash ISA or a stocks and shares ISA?
Having an ISA strategy – or deciding which ISAs you want and how to spread your allowance across them – means you could well be able to ‘set and forget.’ You can do what you need to do now and then not have to worry for another year or more.
But how do you choose which ISA is right for you?
Over the last 12 months, higher interest rates have made cash ISAs the most attractive they’ve been for years. Does that mean they should replace stocks and shares ISAs?
No, there is a place for both. But thankfully, you don’t have to choose between one or the other.
You can have both. And there’s good reason to, particularly if you’re saving for the short, medium, and long-term.
The bottom line is that cash ISAs and stocks and shares ISAs have different functions. It’s important to understand them and their differences so you can make the most of both.
They shouldn’t be confused – for example, it’s probably not a good idea to put your retirement pot into a cash ISA just because rates are higher right now. Equally, you don’t want to invest your emergency savings in a stocks and shares ISA, because you may need it urgently and want it to be easily accessible.
But if you can develop an ISA strategy that uses both, allocating your money in a way that supports your near- and long-term goals, then your money will be working hard for you now and over the years to come.
What’s more, if you open your ISAs at the start of the tax year, your money has greater potential to grow and compound. Go one step further and start a Direct Debit for your contributions, and you’re set up to invest every month without having to think about it.
Need some help deciding how much to save or invest, or understanding which ISAs in particular would be right for you? Book a free call with one of our experts today.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Tax treatment depends on your individual circumstances and may be subject to change in the future. Past or future performance indicators are not reliable indicators of future performance.