When you're looking to invest your savings, you may wonder 'are cash ISAs safe?' We're going to look at the factors you'll need to consider before you commit to putting your money into a cash ISA.
Let's go back to basics for a moment. There are cash ISAs, stocks & shares ISAs, lifetime ISAs, junior ISAs and innovative finance ISAs. The overall limit for ISA contributions in the 2020 / 2021 tax year is £20,000 and you can share your ISA allowance between a cash ISA, a stocks & shares ISA and an innovative finance ISA in whatever proportion you choose.
In simple terms, cash ISAs pay interest, stocks & shares ISAs mean your investment can be in shares or funds, and innovative finance ISAs enable you to put your money into 'peer-to-peer' platforms.
We'll now look at each in more detail.
Cash ISAs are similar to a savings account, but no income tax is payable on interest received. As a result, you can invest up to the maximum amount each tax year with savings never being subject to income tax over the duration.
A major plus point is that there's no risk of capital loss with a cash ISA because cash isn't being invested. And if the worst happens and the ISA provider ceases to operate, cash ISAs are covered by the Financial Services Compensation Scheme (FSCS) up to a maximum of £85,000.
There are two types of cash ISA; instant access and fixed-term. The instant access cash ISAs enable you to withdraw your money when you choose, whereas with a fixed-term cash ISA, you'll be able to get your money back at the end of the term. However, some providers will allow a withdrawal to be made, although there may be a penalty imposed.
Stocks & shares ISAs
A stocks & shares ISA is a tax-efficient way to invest in listed companies. The money you invest in a stocks & shares ISA is not subject to capital gains tax, dividend tax, nor income tax.
Under the terms of the FSCS, a stocks & shares ISA is treated differently to cash ISAs because the first £50,000 is protected if the provider goes into liquidation; not the £85,000 of a cash ISA.
Depending upon where the money is invested, a stocks & shares ISA will carry more risks than a cash ISA. However, it is possible to reduce the level of risk by investing in relatively safe choices, or increase the risk and potential reward by buying shares in companies that may suffer capital losses.
Innovative finance ISAs
An innovative finance ISA is a peer-to-peer loan where investors typically earn higher rates of interest than a savings account, and the interest is not taxed.
With these ISAs, your money could be used to benefit small businesses, but your investment will not be protected by the FSCS and there's a chance that you won't get your money back because there's no guarantee that borrowers will be able to repay their loans.
With deposits of up to £85,000 protected by the FSCS, and a guaranteed return, cash ISAs make a strong case for being the safest form of ISA. Furthermore, if stocks & shares ISAs decrease in value, your return is not guaranteed, and there's no certainty that their value will increase. Meanwhile, the innovative finance ISAs do not have FSCS protection and it's possible that loans could go unpaid, leaving you out of pocket.
However, even cash ISAs should not be considered completely safe because if you invest, for example, £90,000 in a financial institution that closes, you would lose £5,000.
If you would like to find out more about cash ISAs, take a look at our fixed rate cash ISAs page.