Cash ISA vs stocks and shares ISA: what's the difference?

This guide reveals the key differences between the two most popular types of individual savings accounts (ISAs), helping you to decide between a stocks and shares and cash ISA.

Cash ISAs and stocks and shares ISAs are the most common types of ISA, and deciding which might suit you best can be difficult.

Here, we explore both thoroughly, detailing the pros and cons of each. 

Summary

• A cash ISA is a savings account for an individual that pays you tax-free interest on your money.
• When you open a stocks and shares ISA, your money is invested in the stock market.
• In the last 10 years, the average return on stocks and shares ISAs has been 9.64% annually, versus 1.21% for lower-risk cash ISAs.

Learn more: ISAs vs savings accounts: which is better for you?

What is a cash ISA?

A cash ISA is a savings account for an individual that pays you tax-free interest on your money.

You can currently open one per year, and the overall limit for ISA contributions is £20,000.

From April 2024, you can open multiple ISAs of the same type, but the ISA allowance has remained unchanged. 

If you choose to open a cash ISA and a stocks and shares ISA, you’ll still need to ensure you don’t exceed the £20,000 limit. 

Most cash ISAs are ‘flexible’ ISAs, so you can withdraw money from your ISA and replace it within the year to guarantee you get the total possible amount of tax-free interest.  

There are some non-flexible ISAs, known as fixed-rate ISAs, which offer competitive rates, but it’s vital to consider whether you’re willing to lock up your savings for a set amount of time before committing.

If you need the money within the fixed period, you’ll be charged a penalty to access it.

Simply put, if you’re over 16 and a UK resident, you can open a cash ISA and earn tax-free interest on up to £20,000 a year. 

If you’re not ready to start actively investing your money and you’d like to keep your level of risk low while maximising your savings as you earn them, a cash ISA might be a better option than a stocks and shares ISA.

We'll now look at the pros and cons to consider.

The pros of a cash ISA

• Tax-free interest on your savings. 
• No risk that the value of your savings will go down.  
• Anyone over the age of 16 can open a cash ISA.
• People under the age of 16 can open a cash junior ISA.
• ISAs are portable, so you can choose to transfer your cash ISA into a stocks and shares ISA (or the other way around) at any time.
• Cash ISAs come with fewer extra charges compared to stocks and shares ISAs.

The cons of a cash ISA

• High introductory interest rates can fall quickly, leaving you with lower interest rates.
• Fixed-rate ISAs may lock your money away for a set period of time and can cost you if you suddenly need the money.
• ISAs have a capped contribution limit of £20,000 per year, limiting how much interest you can accrue.
• If the interest rate you receive is lower than the rate of inflation, your money will lose value in real terms.
• ISAs can’t be held by two people; they are for individuals only.
• If your ISA is inherited when you pass away, it may be subject to inheritance tax, depending on the beneficiary.

What is a stocks and shares ISA? 

A stocks and shares ISA is, in some ways, similar to a cash ISA, but there are important differences.

If you’re over 18 and a UK resident for tax purposes, you can open one stocks and shares ISA annually, although these rules will change from April 2024.

As mentioned above, the annual contribution limit is £20,000 across all the ISAs you have open. 

When you open a stocks and shares ISA, your money is invested in the stock market. You can either invest in funds or do your own research and buy your own stocks. 

Stocks are a type of financial security traded on the stock exchange.

They represent shares of ownership in a publicly traded company and can be a good investment for people who have the time to watch their money grow.

While they have an increased chance of long-term rewards, they also come with an increased level of risk, and these factors must be appropriately balanced. 

What is the average stocks and shares ISA return?

To contextualise the increased chance of better returns — in the last 10 years, the average return on stocks and shares ISAs has been 9.64% annually, compared to 1.21% for lower-risk cash ISAs.

Here are the pros and cons to consider.

The pros of a stocks and shares ISA

• Any money you gain from your investments is tax-free.
• Stocks and shares ISAs historically tend to provide a better return on investment than cash ISAs.
• Anyone over the age of 18 can open a stocks and shares ISA.
• Stocks and shares ISAs are a great way to invest in the stock market with support and guidance.
• ISAs are portable. You can transfer your cash ISA into a stocks and shares ISA (or the other way around) at any time.
• Many different investment options are available, from trusts to corporate bonds.

The cons of a stocks and shares ISA

• There’s no guarantee that your ISA will increase in value, and it will always be subject to fluctuating market conditions. 
• Many account charges apply to stocks and shares ISAs for things like fund management and buying and selling, and these can reduce your gains or compound your losses.
• ISAs have a capped contribution limit of £20,000 per year, limiting how much interest you can accrue.
• ISAs can’t be held by two people; they are for individuals only.
• If your ISA allowance is inherited when you pass away, it may be subject to inheritance tax, depending on the beneficiary. 

Which ISA should I open?

First introduced in 1999 by then-chancellor, Gordon Brown, ISAs have become increasingly popular in the decades since.

Savers appreciate tax-free interest and gains, and for many, stocks and shares ISAs are a way to become familiar with the stock market. 

The ISA that best suits you depends on your investor profile and financial goals.

If you’re risk-averse, you might prefer a cash ISA. If you’re interested in getting a higher return on your investment, you might enjoy growth from a stocks and shares ISA.

If you’re somewhere between the two, you might like to do both.

You could invest, for instance, £15,000 in a cash ISA and the remaining £5,000 of your allowance in a stocks and shares ISA.

If you found this article helpful, you might also find our article on how many ISAs you can have informative, too. 

For help determining your investor profile and identifying your financial goals, contact Unbiased today.