With the ISA deadline just around the corner, you may be tempted to open an ISA account. But which type of ISA should you go for? Here’s what you need to know about the differences between a stocks and shares ISA and a cash ISA.
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When is the ISA deadline?
The current tax year ends at 11.59pm on Tuesday 5 April. This means you’ve got until then to use up your annual £20,000 tax-free ISA allowance. While it may seem there’s plenty of time until then, there are reasons why you shouldn’t wait until the last minute.
This tax-free allowance gives you the power to put money into any type of ISA. And any returns you earn remain tax free year-after-year. If you don’t use your full allowance for the 2021/22 tax year, then you lose it. It doesn’t roll over to the next tax year. However, for the 2022/23 tax year, you do get a new £20,000 tax-free allowance.
Should you choose a stocks and shares ISA or cash ISA?
Remember, your tax-free allowance covers you for any type of ISA. So, you can stash the full £20,000 into a stocks and shares ISA or a cash ISA. Alternatively, you can split your allowance across different ISA types. So, if you stash £5,000 into a cash ISA, you’ll still have £15,000 of your allowance to put into a different type of ISA in the same tax year.
However, it’s fair to say that most will stick to opening, or contributing to, one type of ISA in any given tax year. So, if you’re weighing up whether you should open a stocks and shares ISA or a cash ISA, you’ll need to decide on whether you feel comfortable investing your wealth to possibly secure a higher return.
Investing is massively different from saving as your wealth is at risk. In other words, the investment portfolio in your stocks and shares ISA can rise and fall in value.
By putting your money in a cash ISA, you’ll definitely not lose anything. However, your savings are unlikely grow significantly given that currently, the highest cash ISA rate is a pitiful 0.82% AER variable!
On a similar note, while your money is technically 100% safe in a cash ISA, it is important to consider how inflation can erode your wealth. The UK inflation rate is soaring and currently stands at a 30-year high. Plus, further inflation rises are expected later this year. As a result, while your money is safe in a cash ISA, its real value will decline over time given that interest rates are considerably lower than the rate of inflation.
In contrast, if you open a stocks and shares ISA, the higher potential returns on offer give you some chance of keeping up with inflation. Of course, your investment may fall as well as rise. This is a risk taken by everyone who invests.
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How do stocks and shares ISAs compare to cash ISAs?
According to the most recent data, the average return from a stocks and shares ISA was 13.5% for the 2020/21 tax year. And Hargreaves Lansdown notes that general stock market returns have beaten returns from savings accounts in 91% of ten-year periods when looking at data spanning the past 120 years!
As a result, it’s not difficult to see why many opt to use their ISA allowance to invest rather than save.
However, before you dive in and make a decision, if you are looking to invest, bear in mind that past performance shouldn’t inform future investing decisions. In other words, there are no guarantees that past trends will repeat themselves in the future.
If you’re considering opening a stocks and shares ISA, take the time to read our investing basics guide to learn the ropes. The guide will also help you to avoid common investing mistakes.
Looking to open an ISA before the deadline? Take a look at The Motley Fool’s top-rated stocks and shares ISAs.
Please note that tax treatment depends on your individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
