Savings account Guides

ISAs - an introduction

Writes Hazel Cottrell hazel.cottrell@consumerchoices.co.uk

It may only constitute three little letters, but the importance of an ISA as a tax free savings mechanism cannot be understated... (Updated 6/10/09)

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If you have savings, and are not using an ISA, then you are almost certainly paying too much to the taxman.

ISAs offer generous tax advantages to everyone in the UK and over the years the government has simplified ISAs considerably, so now there really is no excuse not to reap the benefits!

In this guide we look at the basics of ISAs and show you why it makes sense to make the most of tax efficient savings.

Once you've digested this guide, make sure you compare ISA accounts to find the ISA that most accurately suits your needs.

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What are ISAs?

An ISA (individual savings account) is basically a tax free wrapper into which you can place cash or shares.

Rather than a product itself, it is more like an umbrella that protects you from paying tax on other products.

An ISA allows you to save money without paying tax!

There are two types of ISA, cash ISAs and stocks and shares ISAs:

A cash ISA is one of the simplest products on the financial market. It is simply a savings account that allows you to save money without having to pay any tax on the interest you receive.
A stocks and shares ISA is essentially a tax free wrapper that you can use to protect your investments from taxation.

You can pay into one of each type during the tax year.

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Who can have an ISA?

To open an ISA you must be:

A UK resident (or a Crown employee serving overseas or married to such an employee)
Aged over 16 for a cash ISA and over 18 for a stocks and shares ISA.

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How much can I save in an ISA?

For the tax year 2009/10, your ISA allowance is as follows:

Your combined investment (in a cash ISA and stocks and shares ISA) can be up to £7,200
You can invest up to £3,600 of this balance in a cash ISA

These allowances leave you with 3 options:

Fill your cash ISA to the max - You could use the full cash allowance and invest £3,600 in cash (leaving you with the option to invest up to £3,600 in stocks and shares).
Put it all in shares - If you don’t want a Cash ISA at all, you can invest the full £7,200 in stocks and shares.
Make the most of ISA flexibility - If you invest less than £3,600 in cash, (for example, if you only invest £1,000 in cash) you can invest the entire remaining balance (in this case £6,200) in shares.

In the April 2009 budget, Alistair Darling announced that ISA limits would be increased.

He said the total annual limit for investment in ISAs would be increased from £7,200 to £10,200 and the amount which can be saved in a cash ISA would be increased from £3,600 to £5,100.

The higher allowances have been available to people aged 50 and over since 6 October 2009. The rest of the population will have to wait until 6 April 2010 (the next tax year) to make the most of these new limits.

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Where can I get an ISA?

Cash ISAs are offered by banks, building societies and National Savings & Investments. To ensure you are getting the best rate, it’s crucial to compare ISA deals and read the terms and conditions of the account.

You can only have a cash ISA with one provider in any tax year, which means you can’t split your allowance between accounts. However, you can have Cash ISAs from different providers in different years.

There are several routes you can go through to buy shares ISAs, including buying directly from a fund manager or through an independent financial adviser. More information on this can be found in our guide to shares ISAs.

To open an ISA, you will normally need to show some form of identification, such as your passport or driving licence.

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When to open an ISA

The tax year runs from 6 April to 5 April the next year. You get a new ISA allowance each tax year and it’s a good idea to use as much of your allowance as you can within that time. If you don’t use it, you lose it - unused allowances don’t rollover to the next year.

However, once you have put money into your ISA, you can keep it in there, earning tax-free interest, for as long as you like. This means it’s possible to accumulate substantial amounts in ISA wrappers over the years.

You can pay money into your ISA at any time of the year but many people do leave it to the last minute, making March a busy month for ISA sales!

Ideally, you should park as much cash as you can in your ISA at the beginning of the tax year, to earn the maximum amount on interest on it.

However, you should also consider whether you will need access to the money soon as money withdrawn money cannot be re-invested once you have used up your allowance (see next section).

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Withdrawals

Many easy access cash ISAs will allow you to withdraw you money at any time without penalties.

However, you should think twice before making withdrawals!

Any money withdrawn from a cash ISA or stocks and shares ISA cannot be returned to top it back up. You can only pay in your set allowance each year, regardless of how much you withdraw.

For example, if you put £2,000 in your cash ISA, you could still add a further £1,600 to it. If you withdraw £1,000 later in the year you could still only put a further £1,600 in, making your total ISA balance for the year £2,600.

If you put the full £3,600 in your cash ISA at the start of the year and then withdrew half of it later, you would still not be able to pay in any more until the next tax year.

Having said this, if you don’t think you are likely to pay in more than £3,600 over the year, making withdrawals isn’t such an issue.

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New ISA Rules

ISAs were introduced in April 1999 to replace old style PEPs and TESSAs. Over the years, they have become less complex as the government attempts to make it easier for people to save tax-free.

As a result, there have been several changes!

Previous incarnations of the ISA, such as mini and maxi ISAs, TOISAs and PEPs have now been scrapped.

There are now just two types of ISA: the cash ISA and the stocks and shares ISA.

The latest changes from the government came into play on 6 April 2008. The new rules are as follows:

All mini cash ISAs, the cash components of maxi ISAs and TESSA only ISAs (TOISAs) have been automatically reclassified as cash ISAs.
All mini stocks and shares ISAs, the stocks and shares components of maxi ISAs and PEPs have been automatically reclassified as stocks and shares ISAs.
When they mature, child trust funds can be rolled over into ISAs.
You are now able to transfer your cash ISAs from previous years into stocks and shares ISAs without affecting your current year’s ISA allowance. You can also transfer your current cash ISA to a stocks and shares ISA as long as you transfer the whole amount.

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Download our complete guide to ISAs >>>

Cash ISAs guide >>>

ISAs vs savings accounts >>>

Switching cash ISAs

Stocks and shares ISAs guide >>>

Article updated Tuesday, 13 January 2009

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