You’ll often hear people talk about an ISA, or an individual savings allowance. It’s got a fancy title and dominates the personal finance pages, but is it actually any different to any other savings account?
Stop right there. An ISA is not a savings account, instead it’s a tax wrapper, and you can invest in it or save in it. With interest rates at all-time lows and inflation picking up, this isn’t a saver’s dream environment, so is it time to look elsewhere with your ISA allowance?
Cash ISAs
Many people keep their savings in a cash ISA for peace of mind.
You can expect to earn around 1% in interest in an easy access cash ISA¹. Depending on whether you mind paying a fee, locking your money up for a fixed period or having a minimum amount in savings, there can be different deals to be had. But with interest rates at rock bottom, you’ll be hard pushed to find much better.
So why save in an ISA rather than a normal account?
An ISA protects your savings and the interest from it in a tax-free wrapper. This tax year (2017/18) the allowance is £20,000.
But with UK inflation now tracking at 2.3%, this cash is likely to be worth less in a year’s time. And with everyone in the UK receiving a personal savings allowance, you can have between £500 and £1,000 in interest each year tax free. Which means you don’t really need a cash ISA, as the tax benefit is non-existent for most people.
Stocks and Shares ISAs
A great way to have the possibility of achieving inflation-beating returns on the cash in your ISA is to invest it through a stocks and shares account. You don’t have to pay tax on the profit your investments within the £20,000 wrapper, and your dividend and bond income is also safe from the taxman.
Whilst you can’t carry your allowance over into a new year, it resets annually. Investors should maximise their stocks and shares ISA each year as it’s an efficient way to grow your wealth over the long-term. We’re even witnessing the beginning of ISA millionaires.
But how much can it really help? Imagine you pay the higher rate of income tax and are subject to 20% capital gains tax (CGT). You’ve invested last year’s allowance £15,240 annually for 20 years and generated 3% in each year, on average. Your ISA is worth about £421,800. If you saved this outside of an ISA, you would have to pay at least £21,000 in capital gains tax, assuming you haven’t used your £11,100 CGT allowance elsewhere. By keeping it in an ISA, you don’t pay a thing.
The difference between saving in cash versus investing in stocks and shares boils down to the potential returns. Savers could be losing about £130 a year by keeping their money in a cash ISA, current account or savings account, we found out last year.
Whilst the allure of the cash ISA is slipping amid this low-rate backdrop, don’t overlook it’s stocks and shares cousin. There are plenty of opportunities to be had, especially going into the new tax year.
- Money Saving Expert
