ISAs (individual savings accounts) can be confusing for savers as there are many different types. Indeed, according to recent research from Ford Money, UK savers actually find ISAs more confusing than the offside rule!
With that in mind, today I’ll be looking at the key differences between the cash and the stocks and shares version, and explaining which is the best for retirement savings.
The cash ISA is a very basic savings vehicle that is similar to a standard savings account. With this type of ISA your money is kept in cash.
As with all ISAs, any interest you earn in a cash one is tax free, which is obviously an advantage, especially if you have a large amount of savings.
Every UK saver has a £20,000 annual allowance, meaning you can contribute that amount into the account every year. You can access your money whenever you want with this ISA, although if you withdraw funds it will impact your annual allowance.
While cash ISAs do have advantages, their main drawback is that the interest rates on these products are low. Currently, the best rate is around 1.45% (and that comes with certain conditions), meaning your money is barely going to grow and even then it will grow at less than the inflation rate.
Stocks and shares ISA
In contrast, the stocks and shares ISA is a much more advanced investment vehicle. It’s a tax-free account and you have that £20,000 annual allowance. You can also access your funds whenever you want.
However, the key advantage of this type is that you can invest in a vast range of growth investments such as stocks, funds and other investments. This means that it’s possible to grow your money at a much higher rate.
For example, you could invest in FTSE 100 stocks such as Lloyds Bank or Royal Dutch Shell and pick up dividend yields of around 6%.
Alternatively, if you didn’t want to pick stocks yourself, you could invest in a tracker fund such as a FTSE 100 ETF and simply track the blue-chip index. Or you could invest in a mutual fund such as the Lindsell Train Global Equity fund which has returned around 150% over the last five years.
Overall, this type of ISA is far more advanced than the cash ISA, as it gives savers and investors many more investment options.
Which ISA is best for retirement saving?
So, which is the best one for retirement savings? Well, in my view, the stocks and shares ISA is the clear winner.
When saving for retirement, you want your money to be growing at a rate above inflation (i.e. at least 2% to 3% per year) otherwise you run the risk of your money losing purchasing power in real-life spending terms over time.
And with a shares, this is easily achievable. With this type of ISA, you could potentially grow your money at 8% to 10% per year, or higher, over the long term with the right mix of funds or stocks. In contrast, any money in a cash ISA is going to grow slower than inflation, unless interest rates rise significantly.
Given the choice between the two for retirement saving, the stocks and shares ISA is definitely the one to go for in my opinion.
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Edward Sheldon owns shares in Lloyds Banking Group, Royal Dutch Shell and has a position in the Lindsell Train Global Equity fund. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.