Thinking of opening a Cash ISA? Read this first

The Cash ISA is one of the most popular savings products in the UK. Indeed, according to statistics from HMRC, at the end of the 2017/2018 financial year, Britons had nearly £270bn saved in them.

But is it the best type of financial product to open if you’re looking to build up your wealth? Possibly not. Here’s a closer look at some of the advantages and disadvantages of saving in one.

Advantages

The main advantage of saving in a Cash ISA is that any income you generate on your savings is tax-free. That’s no doubt a big benefit. Whenever you’re given the opportunity in life to shelter income from the taxman legally (which is not often), you should definitely take it. Currently, you can put up to £20,000 per year into a Cash ISA. So if you have spare cash to save, you could potentially build up a large pot of money in which the interest generated is not subject to tax.

Another key feature is that they offer high levels of security. Unlike shares or property, savings within a Cash ISA are not going to fluctuate in value. Furthermore, your savings are protected by the Financial Services Compensation Scheme (FSCS), assuming your ISA provider is UK-regulated. In the event that your ISA provider collapsed or went bankrupt, the FSCS would provide cover of £85,000 per person per financial institution. So, Cash ISAs are essentially risk-free investments.

Also, Cash ISAs are generally quite flexible. If you need to pull your money out of your ISA you can, although this will affect your ISA allowance.

So, overall, they offer flexibility, security, and tax-efficiency. Sounds good, right?

Disadvantages

Hold on – cash ISAs also have a number of disadvantages. One key drawback is that you can only invest in cash savings products such as easy-access savings accounts, or fixed-rate savings accounts. And the interest rates on these kinds of products are very low. According to Moneyfacts, the average easy-access cash ISA rate is currently 1.29%. While that is the highest average rate since 2016, it’s still abysmal. For example, savings of £10,000 would earn you interest of just £129 per year. Is that going to make you wealthy? While you can pick up higher rates if you’re willing to lock your money away for a certain length of time, you then lose flexibility.

Another issue to consider is that the returns from cash ISAs are likely to be less than inflation, meaning any money in them is actually losing value in real-world terms. Inflation refers to the price rises of goods and services over time. You don’t notice it on a day-to-day basis, but over the long run, it can erode your spending power significantly. In August, inflation in the UK was registered at 2.7%, meaning that if your money is sitting in a cash ISA earning 1.29%, it’s actually losing value.

So, while the cash ISA does have benefits and could be useful for those saving for short-term goals, it’s not a great product for building long-term wealth, as the interest rates offered are too low. If you’re serious about making your money work for you, there are better options, such as a stocks and shares ISA or the Lifetime ISA, which offer access to a broad range of higher-growth investments.

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