Cash vs Equity
If you are looking for a tax-efficient savings vehicle, an ISA (Individual Savings Account) is both an attractive and a popular option. According to HM Revenue and Customs (HMRC) statistics, 11.2 million adult ISAs were subscribed in tax year 2018-2019. Why did all of those people choose to invest in an ISA? Simple. ISAs are tax-free. Every adult in the United Kingdom has a £20,000 ISA allowance for 2020/2021. In order to take advantage of the allowance, you must invest before April 5, 2021. Use it or lose it.
When you do invest there are two main types of ISA to choose from: the Cash ISA and the Equity ISA. The type of ISA you choose will depend on whether you are looking to save for the short-term or invest for the long-term.
If you are looking to invest, as opposed to save, the Equity ISA is the smart choice. Like the Cash ISA, the Equity ISA is tax-free, meaning you will pay no tax on earnings from your investments.
There is risk – the level depends on the stocks and shares you choose to invest in and exposure can be limited with diversification – but also the potential for higher reward, if you are prepared to invest your capital for the long-term and hold your nerve if and when the value of your Equity ISA fluctuates.
You won’t pay Capital Gains Tax on gains made in an Equity ISA, making it particularly appealing if you expect to use up your Capital Gains Tax allowance (£12,300 for 2020-2021) with other investments.
You won’t pay tax on dividends paid on shares held in an Equity ISA. You have a dividend allowance of £2,000 per year – but dividend income in excess of this sum will be taxed (7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers and 38.1% for top-rate taxpayers).
You won’t pay tax on interest earned on corporate bonds held in an Equity ISA. Investments in corporate bonds elsewhere would make up part of the Personal Savings Allowance.
Making up your mind
Put simply: the Cash ISA is for savers; the Equity ISA is for investors. If you fall into both categories, it is worth remembering that you can subscribe to both a Cash ISA and an Equity ISA, and both ISAs will be tax-free, as long as you don’t exceed the annual £20,000 ISA allowance.