Isa season is here again, and many are rushing to take advantage of their £15,240 tax-free allowance before the the new tax year starts in April.
Interest rates really are pitiful at the moment. The best-buy instant access Isa pays a mere 1.1%.
In contrast, the FTSE 100 rose by 19% over the past year.
Past performance isn’t a guarantee of future growth, but historically the stock market outperforms cash.
Investment firm M&G found that, for every £1 you invested in shares in 1983 and tracked the rise in the FTSE All-Share Index, you would have an inflation-adjusted sum of £11.66 by the end of last year.
By contrast, each £1 held in a savings account would be worth just £1.33 once you factored in inflation.
The Personal Savings Allowance
The arrival of the Personal Savings Allowance last year means most people can now enjoy tax-free returns on their savings even if they aren’t held in a cash Isa.
The allowance means basic rate taxpayers can earn up to £1,000 interest a year before income tax is due.
Higher rate taxpayers have a smaller allowance of £500 a year, while additional rate taxpayers miss out completely.
That means a basic rate taxpayer can put more than £90,000 in savings and current accounts before they have to worry about exceeding the savings allowance.
Given that the interest rates on traditional savings and current accounts are currently higher than the best rates available on cash Isas, it makes it difficult to argue for keeping any savings you do wish to hold in a cash Isa.
The Dividend Allowance
If you are currently holding investments outside of an Isa you may want to move them into one in order to protect your dividends from the taxman.
The chancellor announced in his Budget that the Dividend Allowance will be cut next April to £2,000.
At present investors can earn up to £5,000 a year in dividends before they have to pay tax, but the cut will mean many will face a bigger tax bill next year.
Investments held within an Isa are free from dividend tax as well as capital growth.
Freedom to change your mind
Finally, if you put your full Isa allowance in an investment Isa it isn’t locked away.
If you change your mind you can move it back into a cash Isa at any point.
Everyone has different needs
So there you have it; four reasons to consider using your allowance on a stocks and shares Isa.
Now, it’s worth pointing out that this strategy certainly won’t work for anyone.
If, for example, you simply aren’t comfortable with taking on risk or don’t qualify for the Personal Savings Allowance, cash Isas can still form part of your saving strategy.
Everyone has different needs, and some will find cash Isas more useful than others.