Cash ISA vs stocks and shares ISA: how to choose

Savers put record amounts of money into cash ISAs in the 2024/2025 tax year amid higher rates but with inflation putting pressure on everyone’s finances, many could be better off using a stocks and shares ISA for their tax-free allowance.

Rates on cash ISAs have hit decade highs in recent months but many of the top deals have been disappearing amid interest rate cuts by the Bank of England.

The top cash ISAs typically offer rates above inflation, with the best buy deals at around 4.37%.

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Putting money into a cash ISA can help those with a low risk tolerance to start saving and also provides more certainty if you are worried about losses or need access to the cash.

But f you are willing to start investing through a stocks and shares ISA,the returns could be higher over the long-term. If you had money in the average cash ISA over the past 10 years, your tax-free savings would have grown to £1,090, according to analysis by Hargreaves Lansdown, while the same sum invested in a global tracker fund might now be worth £2,243.

There are a few factors to consider when choosing between a cash and stocks and shares ISA such as your risk tolerance, the type of returns you want and when you will need access to the funds.

In some cases, you may even need both.

Why you should consider a cash ISA

Cash ISAs may be seen as the poor-performing relation of stocks and shares tax wrappers, but they do have benefits.

A cash ISA provides a fixed rate of return, making it easier to plan your finances. Plus there are versions, such as an easy access ISA, that let you withdraw your money quickly and without a penalty. Additionally, the first £85,000 is protected by the Financial Services Compensation Scheme if the provider goes bust.

Some cash ISAs, typically fixed terms, offer rates of around 5%, which does currently beat inflation. This could be beneficial as a home for your emergency savings given the money is instantly available.

Luke Thompson, director at PAB Wealth Management, said a Cash ISA is a “no brainer” for a cautious investor at the moment. “No risk and a return of around 5% with most providers which would be difficult to match for most cautious funds by the time investment charges have been taken,” he says.

“But, if rates fall as predicted this will have an impact for cautious investors as to whether it is time to start looking for greater returns via a stocks and shares ISA. At the moment with most cautious investors I am saying leave funds in cash and we will assess as and when those rates start to drop.”

Why you should consider a stocks and shares ISA

There are more risks with a stocks and shares ISA as the value may fluctuate. You could endure some bad years depending on how it is invested, as well as the performance of financial markets.

But, over the longer term, investing outperforms cash ISAs and typically beats inflation. A stocks and shares ISA may therefore be best if you don’t need immediate access to the money.

For example, research by AJ Bell for MoneyWeek shows that while the average cash ISA paid 2.7% last year, a stocks and shares ISA investing in global equities returned 12.7%. Meanwhile, an ISA invested in a UK equity fund returned 7.4% on average.

You can still access money from a stocks and shares ISA at any time but you usually get the best returns by investing over a longer period such as five years. This gives your investments enough time to ride out any downturn in the stock market; withdrawing too early could mean missing out on higher gains.

The best of both worlds?

It is not just an either/or decision when it comes to ISAs. You can spread your £20,000 annual allowance across both cash and stocks and shares ISAs, and there may be benefits to doing so.

A cash ISA may be suitable for short-term funds such as emergency savings, especially easy-access products.

Scott Gallacher, director at advice firm Rowley Turton, said: “Clients with a longer time horizon, around five years or more, and a tolerance for investment risk may find Investment ISAs more suitable. However, for shorter time frames - less than five years- or for those preferring caution, Cash ISAs are often the better option.”

Ultimately, the underlying DNA of each kind of ISA is the same.

You have up to £20,000 you can allocate across one or more ISAs every year. The money is protected from tax, and you have the flexibility to transfer from one to another or withdraw your cash at any time - you just need to decide which strategy is best for you.