What's the difference between a cash ISA and a stocks and shares ISA?
Updated 26 March 2020
For the 2020/21 tax year the ISA annual allowance is £20,000 and this can be split between a cash ISA and a stocks and shares ISA. Generally speaking, stocks and shares ISAs have better growth potential than cash ISAs, but they are more risky. The tax treatment depends on the individual circumstances of each client and may be subject to change in future. The value of any tax benefits will depend on individual circumstances.
A cash ISA works just like a savings account, except you won’t have to pay income tax on the interest you earn. Some cash ISAs will give you instant access to your savings, while others demand that you keep the money there for a fixed amount of time. You can also choose between a fixed interest rate or a variable interest rate for your savings.
Stocks and shares ISAs
You can choose different investments for your stocks and shares ISA, and many companies offer fund solutions. These aim to make investing easy by offering a package of different investments held in one fund, designed to meet a risk appetite or a particular savings need.
There are three main factors to consider when choosing between a cash ISA and a stocks and shares ISA and these are: the length of time you’ll be saving/investing, your appetite to risk, and the impact of inflation.
If you’re saving/investing for the long term, typically a minimum of five years, then stocks and shares are likely to generate a higher rate of return.
However, your money in a stocks and shares ISA is at risk; its value could fall as well as rise and you could get back less than you put in.
The higher the risk profile of your investments the more likely they are to experience fluctuations in value and this is why it’s important to match the investment risks you take with the level of risk you’re comfortable with.
In contrast, cash will rise in line with the interest rate payable on your cash ISA and, while the rate may be variable, it won’t change dramatically, delivering slower growth.
But if inflation is higher than the rate of interest you’re earning on your cash ISA - the real value of your money will fall over time. Slowly the buying-power of your savings will be eroded.
The value of an ISA will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested. An investment in a stocks and shares ISA will not provide the same security of capital associated with a cash ISA. The favourable tax treatment of ISAs may not be maintained in the future and is subject to changes in legislation.