Setting aside money can be a good investment for the future if you can afford it. With many products to choose from, trying to understand the difference between a cash ISA and a stocks and shares ISA can be confusing. ISAs can provide a good option when thinking about investing your money.
In this guide, we’ll take you through everything you need to know about two popular types of ISAs. You’ll learn what an ISA is and what it stands for, and the pros and cons of cash ISAs and stocks and shares ISAs. Before we delve into both products, let’s go over the basics.
What is an individual savings account (ISA)?
Often called an ISA, an Individual Savings Account is a savings account that you can use to set aside money that’s not taxed. Since their introduction in 1999, there are different types of ISAs to choose from and you don’t have to go to your bank to get one. Building societies, credit unions and even stock brokers offer them too.
There are four types of ISAs including:
- Cash ISAs
- Stocks and shares ISAs
- Lifetime ISAs
- Innovative finance ISAs
How do ISAs work?
When you deposit money into an ISA, you’re taking advantage of what’s referred to in the investment world as a ‘tax wrapper’. As a tax wrapper, an ISA protects or wraps around your money or investment, keeping them safe from taxation. But, once you take money out, your money is no longer protected and may be subject to tax.
The majority of ISAs have limits on how much you deposit every tax year, which runs from 6 April to 5 April. The maximum amount you can save tax-free in an ISA is £20,000 for the 2022/23 tax year. For most ISAs you also have the benefit of receiving income tax-free interest.
You can also have more than one ISA, but can only open one type of ISA per year. For example, you could use your allowance to pay £10,000 into your stocks and shares ISA. But, if you have more than one cash ISA, you’ll need to choose which one you’d like to contribute to.
Who is eligible for an ISA?
To open an ISA, you must be:
- Aged 16 or older (for a cash ISA) or 18 (for a stocks and shares ISA)
- Either a UK resident or a Crown servant or the spouse or civil partner of one if you don’t live in the UK
What is a cash ISA?
The most simple and basic type of ISA, cash ISAs are much like traditional savings accounts. The key difference is that you don’t pay tax on interest you’ve earned and there is a limit on how much you can deposit per tax year.
The most common types of cash ISAs include:
- Instant access cash ISAs - A flexible account which allows you to withdraw cash as and when you like.
- Fixed-term cash ISAs - These ISAs usually offer higher interest rates, but for a limited time and often require a minimum initial deposit.
- Regular cash ISAs - This option requires you to make regular monthly contributions to qualify for the Annual Equivalent Rate (AER).
Cash ISA pros and cons
Pros
- You can contribute up to £20,000 tax-free per tax year (or up to £1,666 per month)
- You can open a cash ISA if you’re 18 or older
- Can include savings (if from a bank or building society account) or some National Savings and Investments (NS&I) products
- Many cash ISA options to choose from
- Some let you transfer to another provider
- Offers the peace of mind of regular interest
- Easy access to cash makes them a good option for short-term savers
Cons
- You’re only allowed to pay into one cash ISA per tax year
- You can only open one cash ISA per tax year
- Cash ISA rates tend to be lower than normal savings accounts
- Inflation may negate any interest rate you earn
What is a stocks and shares ISA?
A stocks and shares ISA is an investment account that is tax-free. Unlike a cash ISA that lets you hold cash, you’re holding stocks and shares - which you can choose from. Returns from stocks and shares ISAs can be higher than their cash counterparts, but like all investments, they come with higher risk.
While your investments can always go up, they can also lose value. This is why a stocks and shares ISA may not be the most suitable option for you if you have a low attitude to risk.
Types of investments you can choose from include:
- Company shares
- Investment funds
- Corporate bonds
- Government bonds
- Unit trusts
Stocks and shares ISA pros and cons
Pros
- You can contribute up to £20,000 tax-free per tax year (or up to £1,666 per month)
- Can include corporate and government bonds, shares in companies, investment funds and unit trusts
- Returns may be higher if your investment
- You won’t have to pay Capital Gains Tax, Dividend Tax or Income Tax on your profits
Cons
- You’re not guaranteed a return on your investment
- Higher risk means you may lose money
- You’re only allowed one stocks and shares ISA per tax year
- Expect to pay extra costs such as platform, annual management charges and transfer fees
How does inflation affect your savings and investments?
The sobering fact is that inflation means we’re paying more for the essentials such as food, fuel and utilities. The rising cost of living also means that there’s a good chance that the £10,000 you save today won’t be worth as much tomorrow.
Whether you’d prefer the security of a cash ISA or are willing to take a chance on a stocks and shares ISA, inflation can have a negative knock-on effect. Rising inflation usually means lower interest rates - and vice versa. Lower interest rates over the past few years also mean that your savings likely haven’t grown a great deal.
How does inflation affect interest rates?
Inflation impacts every aspect of our life, from weekly grocery shopping, cost of borrowing, to the daily journey to work. However, interest rates are one of the areas where it has the largest impact.
Inflation and interest rates will affect your finances regardless of whether you have funds in a bank account or are taking out a loan to supplement your income. Continue reading to see what occurs when inflation rises and how it impacts the interest rates you're given.
Interest rate levels will be affected by inflation. The higher the rate of inflation, the more likely interest rates will rise. This happens because lenders will demand higher interest rates in order to compensate for the eventual loss of buying power of the money they are paid.
Future-proofing your investments
There’s no way to protect savings from inflation and rising UK household costs. This may leave you wondering whether it’s a good idea to save at all. But, if the last few years have taught us anything, it’s that big events can knock our financial goals off course.
The question is, if your boiler broke tomorrow - would you rather have the option of dipping into a rainy day fund, or have nothing to fall back on? A safety net could mean the difference between falling into debt or bouncing back quickly.
Not buying the goods, utilities and services that are becoming more expensive could help you beat UK inflation - but it’s not always realistic. At the end of the day, we all need basics such as food, shelter and heating.
Here are three tactics to consider:
- Start investing - it could yield a high return, but at a higher risk
- Wait it out - stock markets almost always bounce back
- Cut back - reduce non-essential, discretionary purchases
Using tools such as the Office for National Statistics’ personal inflation rate calculator can help you understand how you’re affected.
This insight can help you understand where your money is going and where you could cut back. If you’re concerned that rising inflation might affect your quality of life, want to explore your options or are thinking about investing, speak to a financial adviser.
How financial advice could help you become a smarter investor and saver
Putting aside savings and growing your money is important - especially in today’s climate. But how do you know what to invest in or how to prepare for long term goals such as retirement? Working with an expert adviser could help you decide whether cash ISAs, stock and shares ISAs or even both products could work for you - and how they fit in the bigger picture.
A financial adviser's goal is to help you get the most from your savings and investments. Their expertise and guidance can help you gain perspective and better understand where you'd like to be today, tomorrow and in the future. Get in touch with our expert team to get matched with a trusted adviser to explore your options.
And, in addition to helping you make your money go further, they can also support you to:
- Create a robust financial and/or investment plan
- Take advantage of cost and tax-efficient ways to save
- Help you understand your appetite for risk and explore investment options
- Compare ISAs to help you choose the right fit for your needs
The choice to take financial advice is up to you. But as many of 950+ happy customers have found, connecting with a financial adviser could be the first step towards a happier financial future.
We’d love to help you take the next step. Our free adviser matching expert service can connect you with an FCA-regulated expert, wherever you’re based. Complete our quick and easy form and tell us how we can reach you, and we’ll connect you with the expert with the right qualifications and experience to suit your financial needs.
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