Isa explainer: should you go for cash or stocks & shares?
Savers have just over four weeks to make the most of this year’s tax-free savings allowance. We look at the different types of ISA available and how to find the one that’s right for you.
Individual Savings Accounts, or Isas, were introduced by the government to encourage more people to save and allow savers to put money aside without paying tax on any interest or profit made on their savings.
There are two main types of Isa – ones that invest in cash and ones that invest in stocks and shares. Dale Scorer, senior financial Planner at EQ Investors, says ISAs can protect your savings and investments from tax, both income and capital gains tax.
“Everyone can save up to £20,000 each year into an Isa; this can be cash or stocks and shares, or a mixture of both.
“And if you are saving on a regular basis, it usually makes sense to use your ISA allowance. If you don’t use the allowance each year you lose it. Using an ISA to hold stock market investments means there is no capital gains tax to pay when you sell your holdings and there is no tax to pay on any income you receive.”
Choosing an ISA
How you use your Isa allowance will depend on why you are saving, says Scorer.
“Your age, income, appetite for risk and attitudes towards impact on the planet and society should all be taken into consideration when you start looking for an ISA.”
Before deciding how much to save, make sure you have between three and six months worth of expenses – mortgage or rent, utility bills and basics like food and clothing – set aside in an easy access savings account.
Once you have that savings buffer, you can shop around for an Isa that best suits your long-term goals.
<subheading> How much can I save into an ISA </subheading>
You can save up to £20,000 into a ISA per tax year, and this allowance can be split between cash ISAs and investment ISAs. The tax year starts on 6 April and ends on 5 April each year, so you have until 5 April 2023 to use this year’s tax-free Isa allowance.
Isa- know how
- You can have several ISAs but HMRC rules mean you can only pay into one cash ISA per tax year.
- You will need to be over 16 and a resident in the UK.
- You can still open stocks and shares, innovative finance and/or lifetime ISA during the same tax year as you open a fixed rate cash or standard cash ISA, so long as you don’t save more than the overall allowance of £20,000 per year.
Cash Isas
A cash ISA works pretty much like a deposit savings account except you pay no income tax or capital gains tax – on the interest you earn.
If you are a UK taxpayer you can earn up to £1,000 of interest and not have to pay tax on it, depending on which income tax band you’re in. This is known as your personal savings allowance and is in addition to your Isa allowance.
Cash ISAs can be a useful alternative to a standard savings account, and some can be opened with as little as £1.
You can choose to make a regular monthly payment or put lump sums in the account as and when you can afford it. The longer you can leave your cash Isa without making any withdrawals the more interest you may be able to earn, cash Isa providers can offer fixed interest deals which tend to pay more interest, if you only make a limited number of withdrawals.
Fixed-rate cash ISA
If you have a lump sum or are saving for a long-term goal these can be an alternative to an easy access cash ISA.
The interest rate, or AER, is fixed during the term, it’s not variable, so these accounts are a longer-term savings option and you will need to commit to saving for the full term of the savings account.
Bear in mind some cash Isa accounts do not allow additional deposits or transfers from other cash Isas, and many will not allow you to withdraw any money during the fixed term.
You can also have cash versions of a Lifetime Isa – see below
Stocks & shares Isas
Some types of Isa allow you to use your savings to buy shares, these are known as either a stock and shares ISA or an investment ISA.
As with a cash Isa they work like a savings account, you can pay in a monthly amount or a lump sum, but instead of leaving your cash in a bank account – as you would with a cash ISA – the money is used to buy shares or funds which invest in a basket of shares.
Most shares also pay dividends if the companies the shares are in are doing well, which are then also used to help the money in your ISA account grow.
Think of the ISA as a wrapper rather than an account in itself, the wrapper is a tax free umbrella around the account which means that the money you invest is not considered liable for capital gains or income tax.
They do come with some risks, but there is more potential to get greater returns, on the money you put in.
To take out an investment ISA you will need to be over 18 and a UK resident.
There are several ways you can pay into an investment ISA. You can choose to do one through an investment platform or an online stockbroker. Or you can do it through a bank or building society.
An investment platform may offer you the option to buy shares and then put them in an Isa wrapper, or you can choose to buy shares from the platform in the form of a fund.
<subheading> Types of stocks and shares Isas</subheading>
Most banks and building societies offer an investment Isa which will normally invest in shares listed on the FTSE-100.
If you’re thinking about investing in a stocks and shares ISA, you will need to bear in mind that this type of savings account does come with some risk, you will also have to pay fees and charges.
So while they are tax-free you will be charged an account and management fee which can be flat, or it can be charged as a percentage of the value of your investment.
Other types of investment Isa include:
Help to Buy Isa: This type of Isa closed to new accounts on 30 November 2019. If you’ve already opened a Help to Buy ISA you can keep saving into your account until November 2029, with a further 12 months to claim your government bonus towards your first home.
A Help to Buy ISA is a government scheme designed to help you save for a mortgage deposit to buy a home. To qualify you must be a first-time buyer and not own a property
If you missed out on opening a Help to Buy ISA, you can open a Lifetime ISA instead which has a similar bonus scheme for first-time home buyers.
Innovative finance Isa: These are peer to peer ISAs which means you are in effect lending your money to individual borrowers who then pays back that money with interest. These don’t invest in the stock market but are used instead by borrowers who may be looking for start-up capital for a business or enterprise. They can be high-risk, although some platforms that offer these types of Isas have contingency funds as these types of Isa are not protected by the Financial Services Compensation Scheme should they collapse.
Lifetime Isa: This is a type of ISA for those saving up for a home or their retirement or both. There are both cash or stocks and shares versions and you can save up to £4,000 a year and you get a 25 per cent bonus from the government. You can only open one up if you are between 18 to 40, although you can keep paying into the ISA and receive the bonus up to the age of 50. You only get the bonus if you use the savings to buy a house, or if you are saving for retirement take it out after you turn 60.
Junior stocks and shares Isa: JISAs are savings accounts for children under 18. You can get a cash JISA or a stocks and shares version. The Junior ISA allowance for the 2022-23 tax year is £9,000. Anyone can contribute to a JISA.
You can switch ISAs or even combine them so long as the amount invested does not go over your annual allowance, you will have to pay a fee though, as most providers you switch charge an admin fee for switching over funds.
If the company that provides your stocks and shares Isa goes bust then you are protected by the Financial Services Compensation Scheme (FSCS).
To qualify the Isa provider will need to be a firm regulated by the Financial Conduct Authority (FCA). The FCA insists all firms separate their money and assets from their client’s money and assets, so if there’s a shortfall then the FSCS can cover any amount lost up to £50,000. If you are mis-sold an investment by a company that goes bust you may also be eligible for compensation up to £50,000.
You can have two or more stocks and shares Isas, so long as you do not invest more than the annual limit, so if you open two accounts you can only pay in £10,000 into each.
What do stocks and shares ISAs invest in?
- Stocks and shares
These are individual company stocks, and shares, experienced investors often research companies before investing in these types of assets. - Exchange traded funds (ETFs)
ETFs are collective investments and will invest in a basket of stocks and shares which reflect a particular index or market - Bonds
Bond funds invest in government or corporate bonds, this is a form of debt and the company or government pays interest to the bondholder. - Unit trusts and investment trusts
These are collective investments, or funds, that invest in a basket of shares or stocks, they are often themed – such as FTSE 100 – so that they track the performance of a sector, such as the UK’s largest companies.
<subheading> Can i go green with my ISA</subheading>
Many savers are using their Isa allowance to help the environment and society and are increasingly looking for sustainable options for their investments.
Tom Stevenson, investment director for personal investing at Fidelity International, said savers wanting to put their money where their ethics are, need to ask themselves what are your personal values, which sectors and companies are you happy to invest in, and which do you want to avoid?
Stevenson said savers should determine whether they want to invest in sustainability-focused funds, funds focused on ethical issues, or socially focused funds with an emphasis on people issues.
“Doing this will help you confidently choose investments in-line with your principles.
“Building a sustainable investment portfolio can feel complicated. Ethics are personal, and sustainable investment funds invest in lots of different ways. But if you don’t have the time, or confidence, to pick individual shares, investing in funds provides diversification and the expertise and dedicated resources of a professional fund manager.
“But if you’re not sure if an investment is right for you, ask for financial advice.”
Rob Morgan, chief investment analyst at Charles Stanley has given City A.M readers five tips for using their Isa allowance:
1. Leave your ISA in cash for now if you can’t decide
If you’re unsure where to invest, you can always secure this year’s allowance with cash now and decide later. There is no charge for holding cash in an ISA.
2. Get some ideas to make your own decision
‘DIY’ investors who wish to select investments themselves can choose from the exceptionally broad range available, from UK and overseas shares, gilts, bonds, investment trusts and ETFs. But with so many to choose from, selecting individual ones can be a daunting prospect. To help make your decision, you’ll need to consider what level of risk you’re willing to take, whether an active or passive investment style works for you, and if there are any themes you’d most like to invest in, for example more ethical or impact investments.
3. Diversify
If you invest too much in one area you are reliant on its fortunes. Diversification can allow you to secure strong long-term returns but without excessive risk and reliance on one or more areas. It’s the process of dividing your investments between different investments, as well as different asset classes, such as shares, bonds, property, cash and others.
4. Consider accounts for your family
With inflation taking a huge bite out of spending power and perhaps more tax rises ahead, it is more important than ever to ensure your finances are as tax efficient as possible.
If you are married or in a civil partnership, it’s possible to organise your affairs efficiently so that tax-free allowances are maximised. Using ISAs a couple can shelter up to £40,000 each year from tax. Meanwhile, Junior ISAs are a popular way for family and friends to build up tax-efficient savings and investments for a child.
5. Pensions are an option
Pensions are often a highly effective means of investing for retirement owing to the tax relief available on payments into them. Currently, anyone under 75 with relevant UK earnings can receive tax relief on pension contributions when they use their annual allowance with a personal pension such as a SIPP (Self-Invested Personal Pension). 20% is added by HMRC and any further higher or additional rate income tax relief can be reclaimed – a potentially simple way of reducing your income tax bill for the year.
The tax treatment of pensions depends on individual circumstances and is subject to change in future.
Is my ISA money safe?
Money held in cash ISAs by UK banks and building societies are covered by the Financial Services Compensation Scheme (FSCS). The FSCS has a savings protection limit of £85,000 per authorised firm, although some banks are part of the same firm, such as Lloyds Banking Group which includes Halifax and Lloyds or the NatWest Group which includes RBS.