3 drawbacks of a stocks and shares ISA

Here are three potential disadvantages of investing in the UK stock market using a stocks and shares ISA.

In a previous article, I highlighted three advantages of using a stocks and shares ISA to invest in the UK stock market.

However, ISAs are by no means perfect. Using them to invest in shares carries far greater risks than other forms of ISA, such as a cash ISA. Furthermore, unlike an occupational pension scheme they do not include employer contributions. Their tax specifics may also not be viewed as positively as those of a SIPP or occupational pension schemes by some investors.

Tax disadvantages of a stocks and shares ISA

Amounts invested in a stocks and shares ISA are made after tax has been paid. This is different than for other types of pensions, such as a SIPP or a workplace pension. Their contributions are made before tax is paid.

This would normally even itself out in the long run because no tax is charged on withdrawals from an ISA, whereas it is on drawings from a SIPP or workplace scheme. However, there is a 25% tax-free withdrawal available on SIPPs and workplace pension schemes. Therefore, it may be the case that an ISA is not as tax efficient as other types of pensions, depending on an individual’s own circumstances.

Of course, no tax is paid on any amounts while they are invested in a stocks and shares ISA. This is the same as other types of pensions, such as a SIPP or occupational scheme.

Also See:

No employer contributions

The introduction of auto enrollment workplace pensions means that employers are required to contribute 3% of an employee’s annual salary to their pension in return for a 5% employee contribution. In some instances, an employer may be willing to pay this into a SIPP instead of an occupational scheme.

Contributions to a stocks and shares ISA are made by an individual, rather than an employer. Therefore, for some people, it may be more logical to make a 5% salary contribution to their occupational pension scheme instead of paying that money into an ISA. This would enable them to benefit from a 3% employer contribution.

While the lack of an employer contribution is not necessarily a weakness on the part of a stocks and shares ISA, it is nevertheless worth considering for employees who are looking at their available pension options.

Risks versus a cash ISA

The risks of investing in the UK stock market are significantly higher than holding cash. Therefore, by its very nature, a stocks and shares ISA is likely to be a far riskier product than a cash ISA. This may help to explain why the latter has historically been more popular in terms of yearly subscriptions than the former.

Of course, cash returns are low at the moment due to low interest rates. This may mean the potential rewards of an investment in shares are also higher than having a cash ISA.

Not Investment Advice Note: Views expressed are those of the writer. The author does not own any stocks mentioned. The article is information, not advice. Share prices can rise and fall. Past returns are not a guide to the future. Please do your own research.