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Comparison of Returns on Different Types of ISAs

When it comes to tax-efficient savings and investments, ISAs (Individual Savings Accounts) offer a great way to shelter your returns from tax. However, the type of ISA you choose can significantly impact the returns you can expect. In this post, we’ll look at the different types of ISAs, including Cash ISAs, Stocks and Shares ISAs, Innovative Finance ISAs (IFISAs), and Lifetime ISAs (LISAs), and compare the potential returns you can earn from each. 

1. Cash ISAs: Safe and Low-Risk

Cash ISAs are a go-to option for many savers seeking low-risk, tax-free interest on their cash. These ISAs are essentially savings accounts where the interest you earn is shielded from tax. They come in two main types: easy-access Cash ISAs, where you can withdraw funds as needed, and fixed-rate Cash ISAs, which offer higher returns if you lock your money away for a fixed term.

Typical Returns:

-  Easy-access Cash ISAs: Typically, these accounts offer interest rates around 4-5% (as per September 2024), allowing savers to withdraw their money at any time without penalties.

-  Fixed-rate Cash ISAs: For those willing to lock their cash away, fixed-rate ISAs may offer slightly higher returns, often around 4-6% (as per September 2024), depending on the term.

Pros:

-  Low risk: Your money is protected by the Financial Services Compensation Scheme (FSCS) up to £85,000.

-  Easy to access: Especially in the case of easy-access ISAs, where you can get to your funds without notice or penalties. 

Cons:

-  Lower returns: While the rates are tax-free, they tend to be lower than other investment- based ISAs, which can limit your long-term growth.

-  Inflation impact: Inflation may erode the real value of your savings over time if interest rates don’t keep up.

2. Stocks and Shares ISAs: Potential for Higher Growth

A Stocks and Shares ISA allows you to invest in the financial markets, such as equities, bonds, and funds. While these ISAs come with more risk compared to Cash ISAs, they offer the potential for higher returns, especially over the long term.

Typical Returns:

The returns in a Stocks and Shares ISA can vary greatly depending on market performance. Historically, equity investments have delivered average annual returns of 7-9% over the long term. However, short-term volatility means returns can fluctuate widely, and there is a risk of loss.

Pros:

-  Higher potential returns: Over time, stock markets generally outperform cash savings, providing the opportunity for greater wealth accumulation.

- No tax on gains: Like other ISAs, you won’t pay tax on capital gains or dividends within a Stocks and Shares ISA. 

Cons:

- Market risk: Your capital is at risk, and returns are not guaranteed. You could lose money if the market performs poorly.

- Management fees: Investment platforms often charge fees, which can reduce overall returns.

3. Innovative Finance ISAs (IFISAs): Balancing Risk and Return

Innovative Finance ISAs (IFISAs) are a relatively new type of ISA that allows investors to lend money through peer-to-peer (P2P) lending platforms like easyMoney. The returns are typically higher than Cash ISAs but come with added risk since your funds are loaned to businesses.

At easyMoney, the loans are secured against UK property, which provides an extra layer of security. 

Typical Returns:

IFISAs often offer returns in the range of 5-10% (as per September 2024), depending on the lending platform and the borrowers' profiles. At easyMoney, investors can target returns of up to 10% (as per September 2024) per annum depending on individual circumstances and the investment tier.

Pros:

- Higher returns: IFISAs generally offer better interest rates than Cash ISAs, making them an attractive option for investors looking for higher income.

- Tax-free earnings: Like other ISAs, your interest within an IFISA is sheltered from tax.

- Secured loans: Platforms like easyMoney secure loans against property, reducing the risk of capital loss.

Cons:

- No FSCS protection: Unlike Cash ISAs, IFISAs are not protected by the FSCS, meaning there is a risk of losing your investment if borrowers default.

- Risk of Borrower Default: While the risk is mitigated by securing loans against property, there is still a possibility that borrowers may default. In such cases, it could take time to recover funds, though the likelihood of not recovering the full amount remains low due to the security of the loans.

4. Lifetime ISAs (LISAs): Ideal for First-Time Buyers or Retirement

A Lifetime ISA (LISA) is designed to help individuals save for their first home or for retirement. You can contribute up to £4,000 per year, and the government adds a 25% bonus on top, making it an attractive choice for long-term savers.

Typical Returns:

Cash LISAs work similarly to Cash ISAs but with the added government bonus. The interest rates tend to be around 3-4% (as per September 2024), depending on the provider.

Stocks and Shares LISAs provide market-based returns, much like a Stocks and Shares ISA, but with the additional government bonus. 

Pros:

- Government bonus: The 25% bonus effectively boosts your savings, making LISAs one of the best options for first-time buyers or retirement savers.

- Tax-free growth: Like all ISAs, any interest, capital gains, or dividends earned within a LISA are tax-free.

Cons:

- Restricted use: The funds in a LISA can only be used for a first-time home purchase or withdrawn after age 60. Withdrawals for other purposes incur a 25% penalty.

- Contribution limits: The £4,000 annual contribution cap is lower than the limit for other ISAs.

Which ISA Offers the Best Returns?

In terms of absolute returns, Innovative Finance ISAs (IFISAs) and Stocks and Shares ISAs have the potential to outperform Cash ISAs over the long term. IFISAs, such as those offered by easyMoney, can provide higher returns of up to 10% per annum (as per September 2024) depending on your circumstances, making them an appealing option for investors willing to accept a higher degree of risk. However, these options are better suited to those with a higher risk tolerance.

For those seeking security over returns, Cash ISAs remain the safest choice, especially for short-term savings goals. They offer stable returns with FSCS protection, although inflation may outpace the interest you earn.

Finally, for first-time homebuyers or individuals saving for retirement, Lifetime ISAs (LISAs) are a great option due to the government’s 25% bonus, but they are limited in terms of usage and annual contribution caps.

Each type of ISA offers unique benefits depending on your savings goals, risk tolerance, and time horizon. If you prioritise security and easy access, a Cash ISA might be the best fit. For those looking to grow their wealth over the long term, Stocks and Shares ISAs and Innovative Finance ISAs (IFISAs) offer higher potential returns, with IFISAs providing a balance between risk and reward through property-backed lending.

By carefully considering your financial objectives and the level of risk you are willing to take, you can make an informed decision about which ISA will deliver the best returns for your money.

Past performance is no guarantee for future results.

Tax treatment depends on individual circumstances and may be subject to change.