Cash ISA vs Stocks & Shares ISA: Which should you choose?
By Boring Money
6 Feb, 2023
Deciding between a Cash ISA and a Stocks & Shares ISA can be a tricky task. Before we dive into the specifics, let’s make sure we’ve got a good grasp of the basics. Do you know how the different types of ISA work? What’s the difference between a Cash ISA and a Stocks & Shares ISA? And when can you, and can't you, use a Lifetime ISA?
What is an ISA?
An ISA (which stands for ‘Individual Savings Account’) is a type of savings account where you can store money – either in cash (with a Cash ISA) or by investing in the stock market (with a Stocks & Shares ISA) – without having to pay any tax. There are also other types of ISA, such as Lifetime ISAs and Junior ISAs.
Also, your £20,000 annual allowance is split across all the ISAs you own. For example - let's say you open a Cash ISA and a Stocks & Shares ISA - if you put £15,000 into your Cash ISA during this tax year, you could put a maximum of £5,000 into your Stocks & Shares one.
What is a Cash ISA?
A Cash ISA is a type of ISA where your money is kept in cash – rather than being invested – where it can gain interest over time. This type of ISA favours high interest rates so that you can squeeze the most out of your money. You can tuck away up to £20,000 into a Cash ISA every year without paying any tax, which sounds like a no-brainer at first, but you should also consider that cash is especially vulnerable to inflation and could lose some of its purchasing power over time.
What is a Stocks & Shares ISA?
A Stocks & Shares ISA is a type of ISA where the money in your account is invested in the stock market with the aim of generating a profit. This type of ISA is more volatile than its cash equivalent, as is the nature of shares and funds, but it can be a great option for those looking to dip their toes into investing within a tax-free wrapper. You can put away up to £20,000 into a Stocks & Shares ISA each year - just remember that, as always, you can lose capital as well as gain it.
Cash ISAs vs Stocks & Shares ISAs
So now we’ve covered the foundations, let’s compare when and why a Cash ISA or a Stocks & Shares ISA would be best for you.
What are you saving for?
When deciding if a Cash ISA or a Stocks & Shares ISA is best for you, it helps to know exactly what you’re saving for in the first place, as this can be a deciding factor in which type of ISA is best suited to your needs.
If you’ve got some extra income that you’d like to make the most out of - but don't mind tucking away for a while - then a Stocks & Shares ISA is a great way to see how far that can take you. You're not depending on this money for any critical goals, such as buying a house, so it's not necessarily the end of the world if the stock market takes a turn for the worse and you end up losing some of your capital. Plus, you're not going to need your money any time soon, so it's not a problem to you if you can't immediately withdraw your funds from your account.
However, if you have a specific and important goal in mind - like buying your first property or a new car - then a Cash ISA will give you a better sense of security as you're not exposed to the potential pitfalls of the stock market. Your money isn't subject to the same level of risk as it would be if it was invested, so Cash ISAs are a good fit if you want to save for something important, and it's usually much easier to withdraw your funds at short-notice than with a Stocks & Shares ISA.
My top tip: If you're between 18-39 and saving to buy your first home or for retirement, consider opening a cash Lifetime ISA, which is similar to a Cash ISA but gives you the added bonus of a 25% government top-up every tax year!
When will you need your money?
Choosing between a Cash ISA and a Stocks & Shares ISA also comes down to when you think you'll need to access your money, as there are differences in how these two accounts work, so being clear on when you'll need to cash in can help you make a decision.
Let's say you’re saving money to put towards retirement, so you can afford the one you've always dreamed of. Maybe you want to travel the world, or maybe you just want to make sure you're comfortable and won't have to worry about making ends meet. Longer timeframes like this are better suited to a Stocks & Shares ISA, where you can let your money accumulate interest over the years, and you aren't going to need to immediately access it at short-notice.
On the other hand, if you're saving for something a little bit nearer or more important on the horizon - a new car in the next year or two, or an emergency fund, for example - this is where a Cash ISA is more suitable. You can usually withdraw funds from a Cash ISA more quickly than with a Stocks & Shares ISA (typically around 1 working day, or immediately if you have an instant-access account!) and you won't need to wait around for your provider to retrieve money from any investments.
My top tip: If you're building an emergency fund, an instant-access Cash ISA will let you earn interest on your savings while also giving you the freedom to withdraw your funds immediately whenever you need it!
The right ISA for your financial goals
There are lots of reasons why you might want to open an ISA. Here are some common financial goals you may be aiming for and which type of ISA would be best for you.
Buying your first home: Cash ISA or Cash LISA
This is an important milestone for many of us, so you want to make sure you’ve got the security that a Cash ISA provides so you don’t end up losing any money. An even better choice would be a Cash LISA, however, so you can benefit from the free 25% government top-up every tax year – just remember you can only deposit £4,000 per year, so this only really works if you’re going to be saving at a slow pace anyway. If you've got good momentum behind saving for a deposit, stick with a trusty Cash ISA instead.
Saving for retirement: Stocks & Shares ISA or Stocks & Shares LISA
Saving up for later life is typically a faraway financial goal, and when you’ve got decades of time on your hands, it makes sense to take advantage of stock market growth - which, historically, has given better returns than cash. If markets take a turn for the worse and you’d prefer to switch to cash, you can always transfer your funds into a Cash ISA, but sometimes sticking it out for the long run is worth the wait. Alternatively, you can also use a LISA for your retirement savings, and you can even choose a Stocks and Shares LISA to get the best of both worlds.
Saving for a big holiday: Cash ISA
Desperate for a holiday ASAP? Use a Cash ISA to put money away as and when you can. This is also a great opportunity to try out budgeting apps such as Plum or Moneybox, where you can separate your savings into different pots for different purposes. You can even enable handy "round-up" functions, which round up every transaction you make to the nearest pound and put the difference into your chosen pot. You'd be surprised how much you can put away each month if you leave it to the apps to crunch the numbers for you.
Putting money away for your kids/grandkids: Cash JISA or Stocks & Shares JISA
If you’re putting some money away for a lucky little one’s next birthday, then a Cash ISA is the way to go, but a longer-term goal – such as a 21st birthday present - would be better suited to a Stocks & Shares ISA. This is also when the Junior ISA emerges as a great alternative. You can save up to £9,000 each year without paying any tax, for the kids to get their hands on once they turn 18. You can pick a Cash or a Stocks & Shares version, but if you've got a lot of time before that all-important 18th birthday, go for a Stocks & Shares JISA.
Buying a car: Cash ISA
Buying a car is a pretty big and important investment, especially if you’re not in a position where you can use public transport to get around day to day. You won’t want to save up thousands of pounds just to lose it if the stock market decides to take a dip! Stick with a Cash ISA to be safe, and you'll also benefit from being able to quickly withdraw your funds if your existing vehicle kicks the bucket and you need to quickly finance a replacement.
Trying out investing: Stocks & Shares ISA
If you’re curious about investing, don’t want to tackle the various and confusing tax rules that come with it, and are only going to invest up to a maximum of £20,000 per year, then a Stocks & Shares ISA is the right ISA for you. Just remember that if you want to quickly withdraw your money, you might have to wait a few weeks for your provider to retrieve the cash that's been invested.
The best Stocks & Shares ISAs
If you’ve decided a Stocks & Shares ISA is the one for you, make sure you head over to our ISA comparison tables to see which providers have our - and our readers' - seal of approval.
