While interest rate rises may be on the medium-term horizon, the income prospects for savers continue to be highly disappointing. At the present time, the best income return that savers using a Cash ISA can hope for is around 1.5%. That’s less than the current rate of inflation, and may mean their spending power declines over time.
By contrast, the FTSE 100 has one of its highest-ever dividend yields. It currently stands at 4.5%, which suggests now could be the right time to buy a range of large-cap income shares within a Stocks and Shares ISA.
With interest rates being close to historic lows, it’s clear holding cash is unlikely to be a profitable exercise for many people when inflation is taken into account. Even if interest rates rise, it may take a number of months or even years for the return on a Cash ISA to move higher than inflation.
That’s especially the case since interest rate rises may be prompted by a higher rate of inflation that leaves many savers less well-off in terms of their spending power over the next few years.
The FTSE 100 may be facing an uncertain period at present as a result of global trade wars and Brexit. However, its dividend yield appears to take this into account. In fact, in the last couple of decades, it has only been higher for brief moments, such as during the financial crisis, when its future was far less certain than it is today. As such, its current price level could represent good value for money from an income investing perspective.
Another reason why holding FTSE 100 shares could be a better idea than having a Cash ISA is their respective tax advantages. Since the first £1,000 of income earned from interest on cash held outside of an ISA is tax free, a saver would need to have £67,000 in a Cash ISA (with a 1.5% interest rate) to start enjoying tax benefits versus a bog-standard savings account.
By contrast, holding FTSE 100 stocks in a Stocks and Shares ISA would lead to greater tax advantages versus holding them in a standard sharedealing account.
For example, there would be no dividend tax or capital gains tax. Therefore, from a tax perspective, it may be prudent to not use up your annual £20,000 ISA allowance on a Cash ISA which, ultimately, fails to offer significant tax benefits.
Of course, having some spare cash in case of emergency is always a good idea. However, relying on it for an income in the long run could prove to be an inefficient use of capital. That’s especially the case while the FTSE 100 appears to offer a highly appealing income investing outlook for long-term investors.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.