Look beyond cash Isas to stocks and shares

Interest rates on cash Isa accounts are too low and stocks do better over the long term. Consider a stocks and shares Isa instead.

The latest individual savings account (Isa) statistics are out and show that while we are flocking to put our money into Isas, we may not be choosing the best ones. The new figures relate to the 2018-2019 tax year and show that the number of people using cash Isas rose by 1.4 million, but stocks and shares Isa subscriptions fell by 450,000.

The decline is a worry when you consider how low interest rates are and that historically the stockmarket outperforms cash. “For a long-term saver, cash makes no sense,” says Holly Black on Morningstar.co.uk.

Black ran the figures and showed that putting £10,000 into a cash Isa paying 0.9% – the best current interest rate for an easy-access account – would produce a £2,522 return over 25 years. By contrast, if you had invested that £10,000 into the FTSE 100 over the past 25 years it would now be worth almost £45,000.

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When it comes to savings accounts, the good news is that savers are returning to Isas after years of neglecting them as the Personal Savings Allowance (PSA), introduced in April 2016, meant you could enjoy tax-free returns in standard savings accounts. The PSA means basic-rate taxpayers can earn up to £1,000 a year in interest on their cash savings before it is taxed. However, the allowance shrinks as your income grows. Higher-rate taxpayers only get a £500 PSA and additional-rate taxpayers get no PSA.

No wonder, then, the group with the most money tucked away from the taxman is the high earners. People with incomes of £150,000 or more have an average of £84,530 in their Isas. At the other end of the spectrum, “there is only a small difference in Isa wealth between low earners and those who would be considered well off but not the highest earners”, says Kate Palmer in The Sunday Times. Those earning £10,000-£19,999 have an average of £23,000 in their Isas, compared with £29,000 for people earning £30,000-£49,999.

How Isas help higher earners

While high earners clearly have more disposable cash to tuck away into Isas, they also have more incentive to do so. Not only do they get no PSA, they also pay more tax on the investments in their stocks and shares Isas. If you earn over £150,000, you pay 38.1% dividend tax, compared with 7.5% for basic-rate taxpayers and 32.5% for higher-rate taxpayers.

The way the tax rules are structured mean a rising income could have a significant impact on how much tax you pay on your savings. A small pay rise, or annual bonus, could bump up your salary into the next tax bracket and have a dramatic effect on your savings tax bill. So it makes sense to build your savings within an Isa so that you know it is tax-free no matter what happens to your income.

One final interesting statistic is that almost a million more women hold Isas than men. But they are more likely to favour cash savings than stocks. This brings us back to equities’ superior long-term performance. While it makes sense to keep a cash savings pot for emergencies – enough to cover the bills for three to six months – over longer time periods stocks almost always vastly outperform cash. “Tell everyone you know, because based on these latest HMRC figures, it seems like the message isn’t getting through,” says Black.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings accounts and credit cards to pensions, property and pet insurance.

Ruth started her career at MoneyWeek after graduating with an MA from the University of St Andrews, and she continues to contribute regular articles to our personal finance section. After leaving MoneyWeek she went on to become deputy editor of Moneywise before becoming a freelance journalist.

Ruth writes regularly for national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping, among many other titles both online and offline.