Is a cash ISA the WORST way to boost your retirement income as the State Pension age rises?

Active senior woman with dog on a walk in a beautiful autumn nature.
Active senior woman with dog on a walk in a beautiful autumn nature.

Since the age at which the State Pension is paid is set to increase to 68 within the next two decades, generating a substantial nest egg by the time you retire could become increasingly important. Clearly, there are numerous means through which to seek to achieve this. One method which may lack appeal, though, is a cash ISA, since it offers a low return and in the long run could destroy an individual’s wealth in real terms.

As such, investing in the stock market through a vehicle such as a Lifetime ISA or a SIPP could be a better move. Here’s why now may be the right time to do so.

Negative returns

While cash ISAs have been relatively popular in recent years, it is difficult to see why that is the case. After all, they offer rates of interest that are consistently below inflation. This means that, over time, every £1 invested in them will have less spending power. Given that inflation has generally been higher than the Bank of England’s 2% target for a sustained period, this looks set to remain the case over the medium term. That’s particularly likely since interest rates are forecast to move higher at a relatively slow pace, and could even be cut depending on how Brexit turns out.

Furthermore, the appeal of cash ISAs has lessened in recent years due to government tax changes. Now, the first £1,000 of interest income received per year in a bog-standard savings account is not subject to income tax. This means that the tax avoidance opportunity with a cash ISA is only likely to be of interest to individuals with significant cash sums.

Investment opportunity

With the FTSE 100 having fallen in recent months, now may seem to be the wrong time to be buying shares. After all, even a cash ISA has outperformed the UK’s main index in the last six months, with it having experienced a 10%+ correction at its lowest point in that period.

However, in the long run, the index is likely to go on to make new highs, with its track record showing that it has the capacity to generate annual total returns of around 7%-8%. Given that it has a dividend yield of approximately 4%, it could offer a positive real-terms income return at the present time, with the potential for capital growth over the long run.

Given that many investors have a long-term time until they plan to retire, they may be able to afford a degree of volatility and the risk of paper losses. Although such features may not be associated with cash ISAs, the reality is that they are likely to lose money for investors when inflation is factored in. As such, utilising the tax benefits of a Lifetime ISA or SIPP through investing in shares could be a significantly better means of coping with a planned rise in the State Pension age.

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