Cash ISAs vs Stocks and Shares ISAsSeptember 2nd, 2013 by Dan Woodruff
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We get a lot of questions about cash ISAs vs Stocks and Shares ISAs. The rules on ISAs are confusing so this article aims to help you choose which is better for you.
- The main differences between cash ISAs vs stocks and shares ISAs
- Which type of ISA is better for you
- What to do with existing investments
Types of ISA
ISAs are Individual Savings Accounts. They are simply a tax-free wrapper around another type of savings or investment account. Any assets held within your ISA are largely free of income tax or capital gains tax. Therefore, it makes sense to use your ISA allowance each year to keep as much of your capital and income away from being taxed.
A cash ISA is a tax-free wrapper around a bank account:
Therefore, cash ISAs are the simplest type of ISA. All you need to do is to find a decent bank account and wrap it in an ISA. This will protect the interest you get on your savings, and you will get all the benefits of your bank account. This usually means access to your savings and security of your assets.
Once your cash ISA is set up you will receive your interest gross of tax. Therefore, if the bank account is paying you 2% interest you get all of this, rather than paying 20%, 40% or 45% tax on it. To put it another way, if you pay income tax at 20%, 2% interest would need to be 2.5% in a taxable bank account. For a 40% income tax payer a taxable account would need to generate 3.33% interest; for a 45% tax payer a taxable account would need to grant 3.63% interest.
Stocks and shares ISA
A stocks and shares ISA is a tax-free wrapper around an investment account:
Therefore, a stocks and shares ISA can be useful to you if you want to protect your longer-term savings and investments from tax on the capital and income. Stocks and shares ISAs tend to be used in conjunction with investments such as unit trusts and OEICs, investment trusts, shares, gilts and corporate bonds. This is a more complex but potentially more profitable area of investment for your ISAs.
Assets held in your stocks and shares ISA are largely free of income tax and capital gains tax. Therefore, depending on your overall tax situation you can save on income tax at 20%, 40% or 45%, plus capital gains tax at 10% or 20%. Shares cannot reclaim the tax credit on dividend payments, but for 40% tax payers you can get sizeable tax savings.
Cash ISAs vs Stocks and Shares ISAs – the main differences
So what are the main differences between cash ISAs and stocks and shares ISAs?
- Amount you can pay in
For the current tax year you can pay in a maximum of £15,240 into ISAs per person per tax year (£20,000 from April 2017).
- What you can invest in
Cash ISAs allow you to invest in cash alone – i.e. bank accounts, fixed rate accounts and the like.
Stocks and shares ISAs allow you to invest in most other types of investments – shares, investment funds etc, but not cash
You can transfer to another ISA at any stage. See out article on the poor advice banks give on cash ISA transfers.
Cash ISA or Stocks and Shares ISA – which is better?
Obviously, this depends on what you plan to do with your savings. In general, we tend to recommend stocks and shares ISAs over cash ISAs because the expected growth on stocks and shares ISAs tends to be better over time. If your stocks and shares ISA is likely to grow at a greater rate over time this means that the amount sheltered from tax will also grow at a greater rate. Therefore, you should get a greater benefit from your stocks and shares ISA over time. Also, our clients tend to have capital gains tax to consider. By using stocks and shares ISAs you can gradually remove your investments from capital gains tax over time.
Of course, there are many reasons why a cash ISA could be better for you. Perhaps you need your savings for a shorter-term project, and don’t want it to drop in value. Alternatively, you might not want to take any risks with your savings, in which case a cash ISA is probably right for you.
What to do with existing investments
If you have existing taxable investments, you should be gradually transferring them into ISAs over time, to take them out of tax. This applies to cash or stocks and shares. You should also use your allowance as soon as you are able to. therefore, don’t wait until the end of the tax year (March); instead use your ISA allowance as soon as you can (APril). This grants you an additional year of tax-free growth.
What next for your ISAs?
If you have existing cash ISAs or stocks and shares ISAs, we recommend that you review them regularly. Why not contact us to see if you can make improvements?