Whether you are saving for retirement, looking at long-term wealth building or have a specific goal in mind for the future, Individual Savings Accounts (Isas) can be a great tool to help you achieve it.
Gains made from money in them – interest earned, dividends or capital gains – are tax free and under current regulations, each person can save up to £20,000 in them every single tax year.
What’s more, the earlier you start, the greater your chances of hitting your long-term targets, as time can be the great multiplier when it comes to your money thanks to the effect of compounding.
Therefore, even if you don’t get anywhere near using up your £20,000 allowance, you can still set yourself lofty targets over time – such as a milestone figure of reaching £100,000.
There are other types of Isa available, but here we’ll look at cash and investing Isas.
Cash ISA
The most-used Isa type is the cash Isa.
Right now with the interest rate on cash Isas somewhere around a competitive 4.5 per cent mark, you can not only earn a reasonable amount on your money, but you can also protect it from inflation, which is running at 3.5 per cent and not projected to drop below 3 per cent until next year at least.
However, interest rates fluctuate a lot over time, meaning you may need to regularly check you are earning the best amount on your money.
How long it takes to reach £100,000 depends on multiple factors, such as your initial deposit amount, ongoing contributions and your interest rate.
Example 1: £2,000 lump sum to start and £250 saved per month, at an average of 3.5% interest.
In this scenario, you would cross the £100,000 mark during your 22nd year of saving regularly. At that point you’d have saved £68,000 of your own money, earning an additional £35,000 in compounded interest.
Example 2: No initial deposit but £400 a month saved at average 3.5% interest.
Some people may have no lump sum to get started with, but have perhaps taken a new job or a pay rise – so bigger monthly savings are possible.
In this scenario, year 16 would be the milestone – with more than £25,000 of the total £102,000 in the pot being interest earned, showing the importance of consistency.
Investing ISA
While the above examples use a flat 3.5 per cent interest rate for cash, there’s no way of knowing what the rate will be a year or a decade from now – it could be far higher or lower, as could inflation.
There may be a better way of reaching your target figure than purely cash, however: a stocks and shares Isa, sometimes called an investing Isa.
Here, your money can be put into the stock market in search of better returns – over longer periods of time, investing has historically always outperformed cash.
If it’s not your area of expertise, there are plenty of automated options where you can simply select your risk tolerance or other preferences and let your money be allocated for you accordingly.
In investing, there is no certainty though – cash savings remain as cash savings and are easily predictable.
A typical World Index Fund has returned between 10 and 11 per cent annually over the last decade, while the FTSE 100 (the UK’s biggest 100 listed companies) generated a 6.3 per cent annualised return over the 20 years from 2003 to 2023, including dividends. Neither are guarantees of the future, but many experts suggest over the long term, an annual return of 6-8 per cent is possible for investors – which over many years can have a significant difference when compared to cash saving rates.
Example 1: £2,000 lump sum to start and £250 invested per month, with an annual 6.5 per cent return.
After 18 years of investing at this rate you’d hit the £100,000 mark – and your own money would only make up half of this total. £56,000 would have been saved through your deposits, with just over £50,000 gains giving a total of £106,866. By year 20, your total gains would outstrip your own deposits and you’d have £127,000 all told.
Example 2: No initial deposit but £400 a month invested, with an annual 6.5 per cent return.
More money going in each month means the initial pot builds quicker, so £100,000 is reached by year 14.
However, as that money has had less time to grow and compound, £67,200 is of your deposits compared to just under £41,000 in earnings. The tipping point for bigger gains comes in year 20 – by which time the total pot would be £192,000.
The lesson remains: starting sooner rather than later is key, as time plays the biggest role in compounding money, even if you start with small amounts.
