Cash ISAs have been in the headlines for all the wrong reasons in the past few months after it emerged that chancellor Rachel Reeves was being lobbied to reduce the annual cash ISA allowance to £4,000.
The Treasury has since confirmed that they are looking into cash ISA reform, with Reeves saying she is trying to “get the balance right between cash and equities to earn better returns for savers, boost the culture of retail investment, and support the growth mission”.
This has, unsurprisingly, sent alarm bells ringing for many cash ISA savers who aren’t keen on putting their money into the stock market.
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But, a reduced cash ISA allowance may not be the end of the world, according to Rob Morgan, chief investment analyst at Charles Stanley.
The stock market typically grows your money more
The stock market has an awkward reputation among some who are not well-acquainted with it. Images of the huge highs and cavernous lows of Wall Street spring to mind.
But, although the value of your investments can certainly go down, over the long term a well-diversified portfolio that is managed responsibly tends to grow.
Morgan notes that “£100 a month saved into cash since April 1999 when ISAs were introduced would be worth £38,493. The same amount invested in global shares would have grown to £160,849".
“Even for a fund aiming to follow the relatively poor performing UK market over the same period would have outperformed cash handsomely at £77,758,” he added.
Historical stock performance is not necessarily indicative of future performance.
“The cash ISA is a very useful product. It allows you to earn interest tax free and can simplify your financial life by keeping that portion of your savings out of tax reporting obligations,” says Morgan. “However, you can have too much of a good thing.”
By stuffing money into cash ISAs rather than investing it, people may be “missing out on better opportunities to build long term wealth,” says Morgan.
If you properly manage and diversify your investment portfolio, then, the stock market has the potential for your money to see much stronger growth over the long term than if it were in a cash ISA.
It is generally good to start investing with the expectation that you will be holding on for at least five to ten years. This way, you do not need to panic over short-term market volatility.
Of course, whether or not you should put more of your cash into the stock market is a personal decision which requires you to consider your appetite for risk.
There are lower-risk options for stocks and shares ISAs
If talk of market crashes and economic downturns dissuades you from opting for a stocks and shares ISA, you shouldn't rule it out quite yet. There are many lower-risk options that you can place in your stocks and shares ISA.
Morgan notes that “those wanting cash-like returns in exchange for a small amount of risk could invest in money market funds or short-dated gilts, both of which are available inside a stocks and shares ISA”.
“Purchasing a UK gilt that has, say, one or two years to run is a bit like using a fixed term savings product, except the capital value can fluctuate and, depending on the individual gilt, will offer a mixture of income and capital return,” Morgan says.
The reason gilts are low-risk is because they are issued directly by the government and so are certain to be repaid, bar a total societal collapse. The UK’s debt management office says that the government has never once failed to pay back the money they raised from issuing gilts.
Another low-risk option for your stocks and shares ISA is a money market fund.
Morgan explains that a money market fund is an open-ended investment fund that invests in a diversified portfolio of cash deposits and other instruments.
The goal of a money market fund is “to produce a competitive cash-like return from the interest received on the investments in the portfolio and to provide short term access for investors,” he says.
Depending on the remit of the fund you decide to invest in, they could also include high-quality, shorter-term bonds that pay either a fixed or floating rate of interest.
There are other tax wrappers for your savings
Another reason it may not be the end of the world if the cash ISA allowance is reduced is that another tax wrapper may be able to temper the blow.
Morgan at Charles Stanley points out that many taxpayers already enjoy a certain amount of tax-free interest on their savings that are kept outside ISAs via the personal savings allowance.
This allowance lets basic-rate taxpayers earn up to £1,000 in savings interest a year without incurring tax. Higher rate taxpayers can get £500 of interest tax-free, but additional rate payers don’t receive any personal savings allowance.
If you’re on a low income (perhaps because you have retired), there is a special 0% rate of income tax on savings income up to £5,000, known as the starting rate for savings.
Morgan also points out Premium Bonds could help protect your money from tax, as prizes are tax-free.
You can buy up to £50,000 worth of Premium Bonds, however, Premium Bonds do not pay guaranteed interest. Instead, each month you are entered into a prize draw where you could win a prize. Prizes start at £25 and go up to £1 million.
The more bonds you hold, the more likely you are to win as each £1 bond is able to win individually – the chance of winning any prize is 22,000 to 1. Despite this, around two thirds of Premium Bonds savers have never won a single prize, according to new data obtained from NS&I by AJ Bell.
How much money is put in cash ISAs?
The tax-free aspect makes cash ISAs an attractive option for savers, but data from HMRC suggests that few are able to get close to saving £20,000 in them every year.
In the 2021/22 tax year, around 3.5 million people saved less than £2,500 in cash ISAs, according to the latest data from HMRC.
Some 870,000 put between £2,500 and £5,000 in these accounts during the period, while 1.3 million deposited between £5,000 and £20,000.
Overall, around £726 billion in total is held in both cash and stocks and shares ISA accounts across the UK, with the majority in stocks and shares, according to data from HMRC analysed by AJ Bell.
Only around £100 billion is held in cash ISAs, and around 14.4 million people in the UK possess only a cash ISA, forgoing the stocks and shares alternative.
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