The Motley Fool

Want a £1m retirement portfolio? Forget a Cash ISA and invest in a Stocks and Shares ISA

While Cash ISAs continue to be significantly more popular than Stocks and Shares ISAs, it’s the latter that offers a higher chance of becoming a millionaire in the long run.

In fact, the best returns available on a Cash ISA at present are around 1.5%, while the stock market has historically offered annualised returns in the high-single digits.

Furthermore, the tax appeal of a Cash ISA has declined in recent years, while the prospect of higher inflation could mean it fails to offer the long-term spending power a Stocks and Shares ISA may provide.

Tax changes

While a Cash ISA previously offered appealing tax advantages versus a bog-standard savings account, today they’re largely ineffective for many people. That’s because the first £1,000 of interest income received outside of a Cash ISA isn’t subject to income tax. As such, an individual would need to have £67,000 or more in a Cash ISA that generates a 1.5% return in order for it to be worthwhile from a tax perspective when compared to a savings account.

By contrast, the lack of dividend tax and capital gains tax in a Stocks and Shares ISA means it has significant appeal from a tax perspective. It could save an investor significant sums of money in the long run – especially since the tax-free allowance for dividends received outside an ISA each year now stands at just £2,000.

Return potential

With interest rates close to historic lows, it’s perhaps unsurprising a Cash ISA offers a disappointing return at the present time. The best interest rates that can be achieved on a Cash ISA are around 1.5%, which is below the rate of inflation. Although there’s scope for them to move higher over the long run, this is likely to be prompted by a higher rate of inflation. As such, they may always lag inflation, meaning investors see their wealth fall in real terms.

Meanwhile, a Stocks and Shares ISA could offer a significantly better return profile over the long run. The FTSE 250, for example, has posted a total annualised return of over 9% in the last 20 years. That’s despite recent threats such as Brexit holding back the index’s performance relative to international comparators, such as the S&P 500.

Risks

Although investing in shares is riskier than having a Cash ISA, over the long run the risk/reward opportunity offered by a Stocks and Shares ISA appears to be highly attractive. Since many investors have a long-term time horizon, investing in a diverse range of FTSE 100 and FTSE 250 stocks could prove to be a better idea than a Cash ISA. The tax advantages, higher returns and the prospect of beating inflation may lead to a better financial future, as well as an increased chance of making a million.

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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.