In my opinion, looking for the best cash interest rates possible within an ISA is not using an ISA to its full potential. The main benefit of an ISA is tax-free growth, which is not being fully utilised if you leave all your capital within the ISA in cash.
You can make a maximum £20,000 contribution into an ISA each tax year. If you have a Lifetime ISA (LISA), then this will be included within the £20,000 maximum contribution limit. This means if you contribute £4,000 into a LISA you will be able to make £16,000 contribution into an ISA. Since 6th April 2017, the limit has been unchanged at £20,000 and arguably the rules have never been simpler for ISA’s.
The main benefit of an ISA is to produce tax free growth, therefore whatever capital is held within an ISA, it will not attract any Capital Gains Tax. This is also useful from an administrative perspective, as there will be no tax to pay and no tax returns to file. If you feel more comfortable with cash due to your risk tolerance and shorter investment time horizon, you could also use National Savings and Investment (NS&I) products, which will also provide interest that is 100% backed by the government and therefore fully protecting your capital.
Interest rates on cash are notoriously low in 2021, with the Bank of England Base Rate at 0.1%. It is likely that any cash held within a cash ISA will yield very little interest. Should you wish to have instant access to your capital with no penalty on withdrawal, the interest rate will be lower, compared with a slightly higher interest rate, if you are willing to tie up your capital for a fixed period. The longer the fixed period, the marginally higher the interest rate will be that is offered.
Interest rates have not always been so low. In 1979, the Bank of England base rate was as high as 17% and more recently in October 1989, they were 14.88%. During these times, cash would have yielded a great deal more interest than today. Historically high interest rates would have been a reason for individual seeking returns from cash within an ISA however these rates are no longer achievable.
When saving for a specific short-term goal (less than five years), cash is a secure asset class to hold. We at Wingate would not recommend holding an asset back investment for less than five years. Holding cash for longer the five years with no plan to use the capital increases inflation risk unnecessarily. Whilst you may receive a slightly higher interest rates if you tie the money up in a fixed term deposit, inflation will usually be running higher than the interest rate you receive on cash. Therefore, your capital will not have as much purchasing power in 5 – 10 years’ time as it does today.
If you have a longer investment time horizon (above five years), you should be considering investing within a Stocks and Shares ISA as an alternative to holding cash. Capital invested within a Stock and Shares ISA can prove to be another tax efficient way to build your retirement pot in conjunction with pensions, which means you will have a greater choice of tax efficient ways to meet your needs in retirement.
There is always a risk to investing your money; however, there are also risks for not investing. Putting your hard-earned money to work through investments is a great way to build wealth in the long term; however, I would always recommend seeking advice of a professional before making any investment decisions. Cash does have its place in any good financial plan, we at Wingate believe you should hold at least six months’ worth of expenditure in cash as an emergency fund for any unforeseen circumstances.
However, if you suspect you may be holding onto too much cash and would like to understand how a financial plan can help with your future investment decisions, please get in contact at Wingate Financial Planning.