‘Beats every cash Isa’: These income funds return 5.2% a year tax free | Personal Finance | Finance

Cash Isas now offer the best rates since 2008, with best buy accounts paying a little over four percent.

That is a huge relief for cash savers after more than a decade of near-zero returns, but is still well below February’s inflation rate of 10.4 percent.

Isa savers who are willing to take on a bit more risk could get an even better total return, by using their stocks and shares Isa allowance instead.

The deadline for using this year’s £20,000 Isa allowance is now just days away at midnight on April 5, which is next Wednesday.

Providers are competing to attract business by increasing their rates, so shop around, said Anna Bowes, founder of rate tracking service Savings Champion.

For those who want easy access, Cynergy Bank and Paragon bank both pay a variable rate of 3.20 percent, while Shawbrook Bank pays 3.17 percent.

Charter Savings Bank offers a market-leading fixed-rate bond paying 4.01 percent for one year, with Shawbrook close behind paying 3.98 percent.

For those able to lock away money for three years, Aldermore and Paragon both pay a fixed rate of 4.15 percent.

Darlington Building Society offers a best buy five-year fixed rate cash Isa paying 4.20 percent, which can be opened in branch or by post, while Secure Trust Bank pays 4 percent in an account that can only be opened online.

Bowes said interest rates on five-year fixed-rate bonds are usually much higher than on one and three-year fixed-rate bonds, but that is not the case today. 

“Banks and building societies expect interest rates to start falling soon, and are cutting long-term rates accordingly.”

Markets expect base rates to peak shortly and fall back to one percent over the next five years, said Laith Khalaf, head of investment analysis at AJ Bell. “This means rates on cash Isas are close to as good as they’re going to get for the foreseeable future.”

It is possible to get a higher rate of income, though, by investing in stocks and shares Isa funds that invest in a spread blue-chip UK dividend-paying companies, known as equity income funds.

AJ Bell’s research shows the average UK equity income fund has returned 5.2 percent a year over the last decade, from a combination of reinvested dividends and share price growth.

During that time, it would have turned a £10,000 lump sum into £16,676.

Over the same period, the average cash Isa turned £10,000 into just £11,181. That’s £5,495 less.

Equity income funds mostly invest in dividend-paying FTSE 100 stocks, such as British American Tobacco, Shell, HSBC, Glaxo and BP.

READ MORE: Best buy 4.2% cash Isa as ‘good as it gets’ with rates set to fall

Dividends are regular payments that companies give investors as a reward for holding their stock. Most firms aim to increase their payouts every year, but there are no guarantees and dividends can be cut or even axed if profits slump.

Similarly, capital is at risk if share prices fall. To reduce the risks, nobody should buy an equity income fund for a period of less than five years, and ideally 10 years or longer.

Cash Isas are perfect for short-term savings, Khalaf said. “Yet over the long run, stock market returns are likely to be higher, albeit with greater volatility along the way.”

Khalaf tips equity income fund Man GLG Income, which currently yields 5.56 percent a year and gave investors a total return of 23.3 percent over the last five years, according to Trustnet.

He also recommends Montanaro UK Income, which yields 3.40 percent and returned 11.3 percent over five years in total.

Another highly respected fund, Evenlode Income, yields 2.70 percent and returned 44.3 percent over five years. 

The City of London Investment Trust is also hugely popular among people who want to generate income from their investments in retirement.

Launched in 1964, this £2billion fund has increased the dividends it pays every single year for an astonishing 56 years, giving investors a rising income.

It currently yields 4.96 percent a year, beating the income from any cash Isa. Again, this income isn’t guaranteed and capital can fall.

Victoria Scholar, head of investment at Interactive Investor, said equity income funds have held firm amid recent volatility. “They’re an established way of generating long-term income in retirement, tax free in a stocks and shares Isa.”