Following the Bank of England’s interest rate cuts earlier this year, lenders across the market have rushed to slash the interest rates they offer on their respective Cash ISA products.
The best Cash ISA rate on the market at the moment is just 0.9%. That’s down from around 1.4% at the beginning of the year. Savers can earn a bit more interest if they are willing to lock their money up for longer.
However, the extra interest received doesn’t compensate for the lack of flexibility that comes with a multi-year Cash ISA. For example, the best three-year fixed rate on the market at the moment is just 1.1%.
With this being the case, savers may be better off looking elsewhere if they want to earn a suitable return on their hard-earned money.
Cash ISA bonus
One of the best alternatives on the market is a Lifetime ISA (LISA). These are very similar to a Cash ISA, in so much as any savings inside the wrapper are not taxable, but they also have some key differences.
For example, you can only save £4,000 in a LISA compared to £20,000 for a vanilla Cash ISA. What’s more, you can only use LISA funds for a first time home purchase or retirement.
The most significant benefit, however, is a 25% government bonus on any contribution. That means if you contribute the full £4,000, the government will add an extra £1,000.
You can do whatever you like with this money. Keep it in cash, or invest in the stock market. Even if you keep it in cash, and receive an interest rate of 0.1%, the government bonus effectively means you will earn a 25% return on your money in the first year.
That’s how the LISA beats the Cash ISA.
The fact that savers can do whatever like like with their funds in a LISA is a big bonus. It also means you can invest the funds in the stock market, which may help you increase the size of your financial nest egg at a rate Cash ISA investors can only dream of.
For example, over the past three-and-a-half decades, the FTSE 250 has produced an average annual return for investors of 12%. At this rate of return, a lump sum investment of £5,000 a year may grow to be worth nearly £100,000 after a decade. Over this time frame, you would only need to provide £40,000, while the government would provide an extra £10,000.
These are the main advantages of using a LISA over a Cash ISA. The government bonus, as well as the tax benefits and flexibility of the product, means that despite the contribution limit, it could be a much better tool for growing wealth over the long term.
Buying a portfolio of single stocks may also help you achieve better returns than the wider market. There are plenty of opportunities available in the market at present after the recent stock market crash.
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Rupert Hargreaves owns no share 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.