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Thinking of relying on a Cash ISA in retirement? I think that may be a major mistake

Peter Stephens
Senior couple at the lake having a picnic

Even though the number of Cash ISAs being subscribed to each year is falling, they remain the most popular type of ISA. That may be because they are a simple means of generating an income, or because many individuals have always used Cash ISAs and see little reason to change.

For retirees, Cash ISAs may pose a significant problem, though. The returns they offer are relatively low, and may be insufficient to generate the second income they are hoping for. In fact, over the long run, they may find that their nest egg falls in terms of its real-world value.

As such, having at least some dividend shares within a retirement portfolio may be a worthwhile move.

Low returns

At the present time, the highest interest rates that are available on Cash ISAs are around 1.5%. This means that an individual seeking to generate a second income from them in retirement would need a significant amount of capital in order to do so. For example, in order to generate an income that equals the State Pension of £8,767 per year, a retiree would need a nest egg of £585,000 in a Cash ISA. This is an unrealistic level for most people – even if they are able to contribute the maximum £20,000 per year into a Cash ISA.

Perhaps even more worrying for retirees is that the returns on a Cash ISA are below inflation. This means that the spending power of the capital within a Cash ISA may be declining each year. With life expectancy continuing to increase, there is a risk that even a relatively large nest egg at retirement may be insufficient to produce a healthy income return throughout older age.

Risk/reward

Clearly, losing money is highly undesirable at any age. However, it is perhaps even more so during retirement. Therefore, it may not be advisable to have too much exposure to risky assets such as shares.

However, having some dividend stocks in retirement could prove to be a worthwhile move. They offer significantly higher income returns than a Cash ISA at the present time, with the FTSE 100 having a dividend yield of over 4%. And while there could be volatility ahead, and a bear market cannot be ruled out due to the risks faced by the global economy, the risk/reward ratio on shares could prove to be attractive for some retirees.

As ever, diversifying among a range of stocks may be prudent, since it can reduce an individual’s exposure to company-specific risk. So too can owning other income-producing assets such as bonds. However, with income shares generally having significantly higher yields than many other income-producing assets, they may be able to offer the kind of returns that many retirees desire. In any case, relying solely on a Cash ISA to fund expenditure in retirement could prove to be an unwise move over the long run.

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Motley Fool UK 2019