Article

Could your cash ISAs be working harder?

Many investors do not realise it is possible to easily switch from a Cash ISA to a Stocks and Shares ISA.

| 5 min read

Cash savers tend to be hit hard by inflation when interest rates on cash lag behind rises in the cost of living – something that has been all too evident recently with UK inflation topping 5%.

Even at a fairly modest rate of 2.5%, a basket of goods and services that cost £100 ten years previous would cost £128 today. It means that if you aren’t earning returns on your savings and investments over and above the rate of inflation your wealth is going backwards. An inflation rate of 5% to 6%, as we are seeing currently, the damage starts to get very significant when you aren’t getting paid anywhere near that in interest.

Despite this, according to the Bank of England, almost £300bn is invested in Cash ISAs in the UK. The Cash ISA has been a very popular product for years, providing the ability to hide a chunk of savings away from the tax man every year. Money invested in cash ISAs remains tax-free – but these days, it is pretty much return-free too. It begs the question – could cash tucked away Cash ISAs or standard savings accounts be working harder?

Preserving spending power

The answer is almost certainly yes, but only for those happy to take some risk and commit for the longer term. As I pointed out in my previous article, "Is cash really king?" the spending power of cash tends to go backwards over time – and there’s reason to believe the erosion of its value will not let over the next few years. Other assets – such as company shares – don’t offer the security of capital, and you could get back less than you invest, but over long periods leaving too much in cash could be more toxic to your wealth than taking risks with investments.

It can of course be a bumpy ride when investing. When you buy shares, you are buying small slices of companies and get a share of growth and profits. Profits don't always go up and companies can shrink as well as grow. In addition, the stock market rises and falls depending on people's confidence in the economy and in businesses. It’s therefore necessary to think long term and only commit whatever amount of money you aren’t going to need in the next few years.

Yet what is higher risk in the short term can be far less so in the long run. A well-managed and diversified portfolio gives you the prospect of decent long-term returns that can drive your wealth forwards rather than backwards.

ISA opportunity

Many investors do not realise it is possible to switch from a Cash ISA to a Stocks and Shares ISA without losing the valuable tax-free status of their savings – simply by completing a transfer request. It’s possible to switch back again if you need to.

For some, Cash ISAs are somewhat redundant anyway. The personal savings allowance introduced from April 2016 means that many people no longer pay tax on their savings interest on ordinary bank and building society accounts.

This removed the automatic deduction of 20% from savings income and allows a basic rate taxpayer to earn up to £1,000 in savings income tax-free. Meanwhile, higher rate taxpayers can now earn up to £500 tax free and there is no allowance for Additional Rate payers. With ordinary savings accounts providing similar rates in many cases, and banks now paying interest gross rather than net, the strength of a Cash ISA is questionable. Tax-efficient allowances are generally best used for assets that produce a high level of return, either through income or capital gain.

Flexibility

The possibility of transferring from a Cash ISA to a Stocks & Shares ISA (and vice-versa) is a valuable flexibility not to be overlooked. The stock market offers a greater opportunity to grow your money and has historically performed better than cash over the long term. If you have not invested before you can use Cash ISAs (or a portion of it) to get started and build the foundations of an investment portfolio. If you are already an investor you can use it to add to your portfolio.

Find out how you can start your investment journey, with our help and guidance in the New to Investing section of our website. It is straightforward to transfer your Cash ISA to a Stocks & Shares ISA such as the Charles Stanley ISA, where you can invest in a wide range of funds and shares. Although you should check you won’t incur excessive exit penalties from your existing provider before doing so.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Could your cash ISAs be working harder?

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The information in this article is based on our understanding of UK Legislation, Taxation and HMRC guidance, all of which are subject to change. The tax treatment of pensions depends on individual circumstances and is subject to change in future. This article is solely for information purposes and does not constitute advice or a personal recommendation.

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