A cash ISA earns interest on savings, while a stocks and shares ISA aims to provide returns by investing in stock markets. We look at the facts about these two ways to save. Remember, when you invest your capital is at risk.
What are cash ISAs and stocks and shares ISAs?
An ISA, or Individual Savings Account, is a government-backed, tax-efficient saving plan.
There are several types of ISA, but the two most popular are cash ISAs and stocks and shares ISAs.
- A cash ISA is similar to a savings account, where your money earns a rate of interest as decided by the account provider. You pay no income tax or capital gains tax on your cash ISA account, whereas with a bank or building society account you may have to pay tax if you earn over £1,000 in interest each year, depending on which tax band you are in.
- A stocks and shares ISA is a tax-efficient investment account, where your money is invested in and aims to make returns on the stock markets. You’ll pay no income tax if you sell an investment that grows in value, or on dividends (profits distributed to shareholders). In a general investment account (GIA), you may need to pay tax on any capital gains or dividends if you exceed certain tax-free thresholds.
We’ll look in more detail at these two types of ISA, to help you make an informed decision about which options are right for you.
How does a cash ISA work?
A cash ISA works very much like a standard savings account – your money is held as cash and earns interest.
Cash ISAs come in a variety of formats. Two common types include:
- Easy access, where you are able to take out money when you want, without a penalty. However, the interest rates are usually variable, so they have the potential to change.
- Fixed rate, where you lock your money away for a set period to retain the interest rate. This rate will often be higher than it is for easy access options. However, there are sometimes restrictions on when you can withdraw.
Benefits of a cash ISA
There are various benefits of a cash ISA, some of which include:
- You save without paying any income or capital gains tax on interest earned.
- There is no risk that you will get back less than you put in.
- You will be able to quickly and easily access funds (unless you opt for a fixed term).
As well as the benefits, you should be aware that attractive interest rates could fall later. Also, a cash ISA may not provide returns that keep pace with or beat inflation, which means your money could lose value over time. Finally, if you choose a fixed term account then you may not be able to access your money if you need it.
How does a stocks and shares ISA work?
With a stocks and shares ISA, you put money into a range of investments that can grow in value or pay dividends. These investments might be individual stocks and shares, bonds (a loan to a company or a government) or a fund (a collection of stocks, shares and other assets collected into one investment).
Benefits of a stocks and shares ISA
The benefits of a stocks and shares ISA include the following:
- You invest without paying any tax on profits (the dividends, and/or capital gains).
- A stocks and shares ISA will aim to provide greater returns than a cash ISA.
- Over long periods, compounding (earnings generated from previous years) may produce significant growth.
- Over time, a stocks and shares ISA has a greater potential to meet or beat inflation than a cash ISA.
Alongside these benefits, you should always bear in mind stocks and shares ISAs come with an element of risk. They may well grow your pot faster than cash ISAs, but you are exposed to the stock market which can go down as well as up. In other words, you could get back less than you put in.
See our page on what is a stocks and shares ISA for a simple guide to these investments.
Can I have a cash ISA and a stocks and shares ISA?
Yes, you can have a cash ISA and a stocks and shares ISA. Here are the main things you need to know:
- You can open and put money into one of each ISA type in a tax year. This means you could open and put money into one cash ISA and one stocks and shares ISA in that financial year. However, you couldn’t open two cash ISAs or two stocks and shares ISA, as they are the same type.
- You can split your allowance across both in any way you want, as long as you don’t go over £20,000 combined.
Should I invest in a cash ISA or a stocks and shares ISA?
As a cash ISA often provides instant access to money and is low risk, growth is unlikely to be spectacular. This means it might be a good option for rainy-day savings, or for funding short-term projects.
A stocks and shares ISA on the other hand has the potential to provide greater returns. However, because markets can move up and down, you’ll want to keep it for at least five years.
This means that if you put money into your stocks and shares ISA before a time of poor performance, it will have more time to recover. For this reason, it can be a good option for long-term saving.
When deciding which is the right option for you, there are a few key factors to consider:
- Your financial goal.
- How long you will need to save for.
- Your attitude to risk.
- Your personal circumstances.
Considering these factors can help you decide which is the best option for you.
For example, if you have short-term savings goals, you want to be able to access your money quickly and you are not comfortable with risk, then you might want to opt for a cash ISA.
However, if you are financially secure, you don’t need to access your money in the next five years and you are comfortable with risk, then you might be more inclined to save into a stocks and shares ISA.
Additionally, if you have expensive debts, then it’s often a good idea to pay these off before you start investing.
Of course, choosing cash ISAs and stocks and shares ISAs isn’t an either/or equation – you can pick or choose to reflect your needs. For instance, you could invest in just a cash ISA or just a stocks and shares ISA. Or you could invest in both types, allocating a proportion of funds to each that reflects your financial goals and your attitude to risk.
Ready to start saving for your future?
Thanks to our investment strategies, over the past 10 years Shepherds Friendly members have enjoyed steady returns on stocks and shares ISAs.
You can open yours now in a few simple steps.
Be sure to read through our Important Information Guides for all the key information about our Stocks and Shares ISA. Remember that when you invest, your capital is at risk.