Should you ditch your cash ISA for a stocks and shares ISA?

After a tense build up to the Autumn Budget last year, the rumour mill is grinding again with fears mounting that tax breaks offered to cash savers could be under threat.

The red pages of the chancellor’s Spring Statement revealed that individual savings account (ISA) reform is very much in the government’s crosshairs but what shape it will take is still unknown.

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Currently, it’s possible to shelter up to £20,000 a year from tax across cash and stocks and shares ISAs. But Reeves is thought to be considering a new, lower allowance for the cash version, which could be as little as £4,000 a year, reserving the full allowance for those who invest through a stocks and shares ISA.

The aim is to encourage more money to flow into the stock market instead of savings accounts, which should lead to improved outcomes for consumers and deliver a welcome jolt to the UK economy.

However the government chooses to shake up the ISA landscape, it’s a timely juncture for you consider whether cash or stocks and shares is right for you.

When is cash appropriate?

Cash savings provide the bedrock of most people’s finances and are crucial for our financial resilience. Easy-access savings can provide a lifeline if you’re hit with an unexpected bill or are faced with a serious change of circumstances such as illness or redundancy. For this reason, most financial planners recommend keeping at least six months’ expenditure in a rainy-day pot.

Cash savings can be equally important for older people, as well as cautious investors who are wary of investing too much money in the stock market.

The ‘investment gap’

However, while the availability of cash ISAs remains a crucial way for savers to shelter their returns from tax, holding more than you need can sometimes become a financial risk itself.

Towards the end of last year, research by Barclays identified a so-called investment gap worth £430 billion, made up of 13 million UK adults with more than six months’ income in cash accounts.

As such, some savers could be seriously missing out by sticking with cash.

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The biggest risk is that it’s much harder for cash savings to keep pace with the rising cost of living over time. While you won’t physically lose any of your money if you keep it in cash, its spending power will be reduced in real terms.

The other is that lower returns mean you may struggle to get the growth that you need to achieve your long-term financial goals.

The Barclays research found that one of the most significant barriers to investing is risk, with more than four in 10 non-investors (43%) considering investment too risky. More specifically, when asked about investment risk, 66% said they thought the “risk of loss” meant that they could lose most, if not all their savings.

Although stock market returns are not guaranteed, over the long term, history shows that they typically outstrip cash.

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Looking at the FTSE 100, over the last decade it’s achieved an average return of 7.1% a year. In 2024, it returned 11.8% and achieved double digits in five out of those 10 years – there were only three years with negative returns – 2015, 2018 and 2020.

Over that decade an investment in the FTSE 100 then, would far outpace cash. While you’ve been able to achieve around 5% on cash savings for a while now, the average best buy over that time frame would have paid much less than that, with official interest rates below 1% for much of that period. And, with interest rates still expected to fall over the next year, current high savings rates will have only a limited life span.

However, the potential for higher returns shouldn’t be the only reason to consider investing in the stock market. So, how do you decide whether paying into a stocks and shares ISA is a sensible move for you?

Are you ready to invest?

Despite the appeal of using stocks and shares ISAs to reach long-term financial goals, almost one in five (17%) UK adults have never heard of them, according to new research from the Investment Association (IA) and Opinium. The research also found a quarter (25%) have heard about stocks and shares ISAs but know little else about the tax wrapper.

But before you think about investing, it’s worth asking yourself the following questions:

1) Do you have any debts to repay? If you’ve got any outstanding credit cards or personal loans, it’s a good idea to pay those off first. That’s because you may end up paying more in interest than you would earn in returns.

2) Have you got an emergency fund? Experts recommend keeping at least six months’ outgoings in an easy access rainy-day fund.

3) What’s your investment horizon? Although money in stocks and shares ISAs is easy to access, it’s best not to invest money that you will likely need to access within the next five years. Stock markets will always move up and down, but the longer you are able to tie your money up for, the more time you give your pot to ride out short-term volatility.

4) How would you respond to stock market losses? It’s important to think about how you would react if the value of your investment fell. Stock market volatility is an inevitable part of investing, but it can be disappointing to see the value of your investment fall. Whether you’re looking at the FTSE 100 or the S&P 500, don’t get bogged down by what’s happened over the last few days, weeks or months. Zooming out to the five- or 10-year view can provide some perspective and show that despite the peaks and falls, the overall trajectory is positive.

5) Are you happy to choose investments? Investment platforms offer access to a huge and diverse range of investments including funds, shares, bonds and exchange-traded funds (ETFs). A low-cost well-diversified fund, trust or ETF offering exposure to a broad basket of shares can all be good entry points and they will be much lower risk than individual shares.

The choice can be overwhelming, but good platforms should offer support and guidance to new investors, including recommendations. However, if you don’t want to make investment decisions yourself, you may be able to invest something such as the ii Managed ISA, matched to your risk profile.

Taking the next step

You don’t need a huge lump sum to make your first foray into investing – it’s possible to test the waters and start paying into a stocks and shares ISA with as little as £25 a month, with free regular investing.

Alternatively, if you want to get more of your money working for you sooner, you can start with a lump sum.

However, if you’re funding a stocks and shares ISA with money that’s currently in a cash ISA, it’s important to follow the ISA transfer process to protect the tax-free status of your money.

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You can transfer the whole cash ISA balance or just part of it (so long as both providers support partial transfers).

This can be done by instructing your stocks and shares ISA to complete the transfer for you online. Once you have provided details of the account you want to transfer, it will do the legwork for you.

If you simply cash in an ISA and pay it into your new stocks and shares ISA, the payment will count towards your annual ISA allowance for the year.

It’s also important to note that investing in a stocks and shares ISA doesn’t mean you can’t continue saving in a cash ISA. It’s possible to pay into both a cash ISA and a stocks and shares ISA in the same tax year, so long as your total contributions don’t exceed your annual ISA allowance of £20,000.