Opening a JISA? Beware of the inflation situation

There are few better ways to tax efficiently kick-start your child or grandchild’s financial future than with a Junior ISA (JISA).

As we approach the end of the tax year, which should be considered carefully to make the most of any allowances you may have before they’re lost, Junior ISAs can be a vital tool for saving for your child or grandchild’s future in a tax-efficient way.

Available to anyone under the age of 18, as long as they don’t already own a Child Trust Fund, JISAs can either be cash or stocks and shares accounts.

The beauty of a JISA is that parents and grandparents can contribute up to the annual limit, which is £9,000 in the 2021/22 and 2022/23 tax year, into the account and the savings will grow free of any income tax or capital gains tax.

Subscriptions can be made until the account holder’s 18th birthday, at which point the savings can either be withdrawn by the child or transferred into an adult ISA.

Over the years, stocks and shares JISAs have made up less than a third of all JISAs, with the lion’s share going to cash JISAs.

Number of account subscriptions

Cash is king for UK savings, and this finding extends beyond just Junior ISAs. In a typical year, for example, only around 22% of all ISA subscriptions are directed towards stocks and shares ISAs.

This is not necessarily a bad thing. Cash savings have a very important place in someone’s personal finances, as they provide an essential buffer against an unexpected bill or large expenditure. As rainy-day funds go, they are ideal.

However, there are certain circumstances when stocks and shares accounts may be more favourable than cash accounts:

  • When the money can be tied up for a long period of time.
  • When inflation threatens to erode the value of the savings in real terms.

This is exactly the position we find ourselves in at the moment. Inflation has hit a forty-year high thanks to increasing energy and fuel prices, as well as global shortages of semi-conductors causing supply shortages for many manufacturers globally.

CPI inflation (annual rate, %)

Not only is inflation currently high, but it’s set to remain elevated for some time to come. According to the Office for Budget Responsibility, who provide medium and long-term forecasts for the direction of the economy, inflation is expected to peak this year but remain elevated around the 2% mark for the next four years.

What does this mean for JISAs?

Inflation is the biggest threat to savings as it erodes the purchasing power of the money you eventually save. In short, you’ll be able to buy fewer and fewer goods with the money saved. This is a real danger for cash JISAs, which tend to pay an interest rate above the Bank of England base rate, but which can fall short of the rate of inflation.  

According to MoneyFacts, the cash JISA paying the highest rate on the market as at 1 February 2022 will pay 2.4% interest a year, though at a variable rate in the future depending on the Bank of England’s base rate.

Consider, for example, a parent wanting to open an account on their child’s fifth birthday, and who plans on saving the average amount paid into a JISA (£1,020) each year until their child turns 18.

Assuming no charges and no change to the interest rate in future, the cash JISA will be worth £15,716 on their child’s 18th birthday from contributions of £13,260. However, when inflation is taken into consideration, things look very different.

Once inflation is taken into account [1], the purchasing power of the account will actually only be worth £13,616.

However, if the account is instead invested, then the invested monies stand a greater chance of achieving a return above the rate of inflation, and therefore retaining their purchasing power.

Assuming a moderate rate of return of 5% a year, with 0.5% total charges each year, the stocks and shares JISA will be worth £18,291 on the child’s 18th birthday.

Again, once inflation is taken into consideration, the purchasing power of this account falls to £15,802, though this is £2,542 more than the cash JISA.

Of course, with investing there is no guarantee of return, and the value of the accounts can fall as well as rise. However, as JISAs can’t be accessed for up to 18 years it means the accounts could potentially smooth out any volatility in stock markets.

As we approach the new tax year, in which ISA subscriptions will be reset for the year ahead, parents and grandparents could consider stocks and shares accounts to protect against inflation eroding the real value of savings.

[1] Assuming inflation is 4% in 2022/23 before returning to 2% for the remaining period, as per the OBR forecasts and in line with the Bank of England’s target.