Cash ISA versus cash funds: the basics

Important information - The value of investments and the income from them can go down as well as up, so you may get back less than you invest.

Investors with a low-risk appetite will prefer to keep at least some of their money in cash. Cash is safer than almost all forms of investing, but potentially at the expense of lower returns.

But how do you keep your savings from lagging behind inflation? Cash funds, otherwise known as money market funds, are one option.

• Learn about the cash and cash-like options if you invest at Fidelity.

What is a Cash ISA?

A Cash ISA is a savings account held within an ISA wrapper. It operates much the same as an easy-access savings account. Your money earns interest each year, which is set in advance, but subject to change.

This means you roughly know in advance what your returns will be, unlike with other forms of investing.

The benefit of saving in a Cash ISA over a regular savings account is that any interest earned is free from tax. However, you have a limited ISA allowance of £20,000 a year, meaning any cash savings take away allowance from potential investments.

Savers face some big changes next year. From 6 April 2027, the annual cash ISA allowance for people under 65 will fall to £12,000. The allowance for savers aged 65 and over will remain at £20,000, meaning they will not be affected by the reforms. During the tax year in which you turn 65, you will be entitled to the full £20,000 allowance.

The lower limit will apply only to new contributions. Any money already held in a cash ISA will still be sheltered from tax.

While the cash ISA allowance is being cut for under-65s, the overall ISA allowance will remain at £20,000. This means anyone can keep adding up to £20,000 a year into their stocks and shares ISA.

To prevent people getting around the new rules, under-65s will not be able to transfer money from a stocks and shares ISA - or an Innovative Finance ISA - into a cash ISA. However, it will still be possible to transfer money in the opposite direction.

What is a cash fund or money market fund?

Money market funds are a type of investment fund. Savers’ money is pooled with other investors and used to purchase assets in the pursuit of growth.

Money market funds specifically target “cash-like” assets like bonds from reputable companies and government debt. This makes them lower risk than funds investing in stocks and shares.

There are two types. Short-term money market funds are a safer bet as they target bonds maturing in the next few months. Standard money market funds hold some forms of longer-term debt and so are slightly more risky. But the returns are likely to be higher.

While money market funds often return more than regular cash savings accounts, this is not guaranteed. In high-interest environments, savers may find that easy-access accounts deliver strong enough returns to negate the need for a money market fund.

Rules around money market funds are also shifting. Last year, the government warned that these funds may be too ‘cash-like’ to live in stocks and shares ISAs. It has now confirmed that investors can hold money market funds in stocks and shares ISAs and enjoy tax-free returns. However, money market funds cannot represent 100% of your portfolio. In this scenario, they will be classed as ‘non-qualifying investments’.

It can also take a few days to withdraw your money.

• Open a Stocks and Shares ISA to invest in cash funds

How ISA changes will affect stocks and shares ISAs

The government is also introducing a 22% charge on any interest paid on uninvested cash within a stocks and shares ISA. The government wants to prevent people using stocks and shares ISAs to store lots of cash and leaving it there for long periods earning tax-free interest.

This means investors who want to keep money in cash-like investments within a stocks and shares ISA may want to understand the difference between uninvested cash and money market funds. Money market funds can still be held in stocks and shares ISAs and enjoy tax-free returns, provided they do not represent 100% of your portfolio.

Which is right for me?

This will depend on your appetite for risk. Both options are far less risky than buying stocks and shares, but money market funds carry a slightly elevated risk profile.

However, they are likely to offer higher returns. So, if you are looking to boost your cash by a small margin over a short period of time, then you might want to opt for a money market fund.

You’ll also need to weigh up the impact of the upcoming ISA changes, and what makes most sense for you and your circumstances.

Remember that even though money market funds aim to be similar to cash, they're not as secure as cash because your money is invested.  So, diversification is still important and it's best not to keep all of your savings in one fund or asset.

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Read more from our series:

• Investing in cash in a Stocks and Shares ISA: the basics
• What is the FTSE 100? The basics
• Investing versus saving: the basics