Cash ISAs – Are We Still Partying Like It’s 1999?

Chartered Financial Planner Simon Hartley considers how the benefits of Cash ISAs and savings having shifted since the turn of the Millennium.

The year is 1999. Kevin Keegan becomes England manager; the London Eye is under construction and Britney Spears tops the charts. The minimum hourly wage for an adult in England is £3.60, Basic Rate income tax is 23% and the Bank of England interest rate dances between 5% and 6%.

A lesser-remembered fact is the introduction of the Individual Savings Account (ISA). The ISA allowance back then was £7,000 per annum (of which £3,000 could go into a Cash ISA) – not quite the lofty £20,000 we have available to play with today. Interest within these accounts was, and still is, tax-free, and there are also tax advantages for investors.

Whilst you could use your allowance in either a Cash or Stocks & Shares ISA, with interest rates where they were, you could earn a considerable amount of interest in a Cash ISA without the relative risk of investing. Say you had £20,000 in a Cash ISA and received a modest 5% p.a. – you would be £1,000 better off each year. If you had £100,000, you would receive interest to the tune of £5,000. You would also be saving £230 and £1,150 respectively each year in Income Tax on the interest accrued.

The year is now 2021…

…Probably best to skip what recent times will forever be renowned for.

However, we are now 4 years into the government’s Personal Savings Allowance scheme, which allows savers to accrue interest tax-free in any bank account – up to £1,000 p.a. for Basic Rate taxpayers, or £500 p.a. for Higher Rate taxpayers. In other words, unless you are accruing more than £1,000/£500 respectively in interest each year, there is now little benefit to a Cash ISA over a standard savings account.

This leads us to the next big shift that has occurred over the last two decades. The Bank of England base rate is now a paltry 0.1%, dragging down the rate you can get on your savings elsewhere. Assuming a savings rate of 1% (if you’re lucky!) £20,000 would grow by £200 p.a. and £100,000 (allow me to check my calculator…) would grow by £1,000. So, on the plus side, tax on your savings might be less of a concern in 2021, but only because your chances of a decent return on your cash are much slimmer.

If you were fortunate enough to be able to save £100,000 in 1999 though, what would it be worth today? Well, based on Bank of England rates over the last 20 odd years, it would now be valued at just shy of £166,930; but what would that actually be worth in today’s terms? If we look at inflation (the increase to the cost of living) over the same period, we see that what would have cost you £100,000 in 1999 now costs you £178,367. Therefore, whilst on paper your savings have grown, in reality, its spending power has depreciated by £11,437. This demonstrates that, interest rates aside, holding large amounts of cash over the longer term tends not to be beneficial.

All this talk of the Cash ISA though and we’ve forgotten about its sister, the Stocks and Shares ISA. All the same caps and tax allowances apply to this product, except that with this, your savings are invested in companies, with your potential growth coming not from interest, but from the value of your shares increasing, or through dividends paid out by these companies. So how does the growth compare? Using a cautious multi asset strategy as an example, we see that £100,000 invested 1999 would have a value of £218,181 in 2020 [1]. That’s an increase in value of £118,181, but, more importantly, an increase in real spending power of £39,814 after adjusting for inflation. Of course, past performance cannot guarantee future returns but, over the longer term, a Stocks & Shares ISA could offer greater protection from inflation.

So, what is the point of Cash ISAs, or indeed cash deposits of any kind? Well, it is still important to maintain a healthy cash balance for short term spending plans and emergencies (typically 3-6x your month expenditure), but too much cash can see your hard-earned capital eroded over time by inflation. When considering how best to make use of your ISA allowance, a Stocks & Shares ISA could offer the same tax advantages as a Cash ISA but with greater potential for real growth above inflation over the medium to long term. Nevertheless, it’s important to take into account your wider objectives and financial plan, and we would always recommend speaking to a professional before making any decisions.

Simon Hartley BA(Hons) APFS
Chartered Financial Planner