With the end of the tax year fast approaching, ISA hunting season is upon us. But as you head off into the financial undergrowth armed with another full ISA allowance, make sure you know what you are getting. Your top ISA questions are answered here.
What is an ISA?
An ISA, or Individual Savings Account, is a tax efficient way of saving or investing your money. The account is a ‘tax-wrapper’ which shelters the underlying investment from taxation. They may not be quite as tax efficient as they used to be, as the government has gradually chipped away at ISA tax concessions, but experts agree that it is still well worth taking advantage of your annual ISA allowance.
How many ISAs can I have and how much can I save?
For the 2011/2012 tax year you can save up to £10,680 through ISAs in a combination of investments such as stocks and shares, bonds and commercial property and a simple savings account.
You can put that entire allowance into stocks and shares, or you can divide it between an Investment ISA and a Cash ISA. You can save a maximum of £5,340 in a cash ISA for the 2011/2012 tax year (April 6th to April 5th) and invest the remainder in an Investment ISA.
From 6th April 2011 your ISA limit will increase to £10,680, £5340 of which you'll be able to save in a Cash ISA.
You can only pay into one cash ISA and one stocks and shares ISA each tax year. However, you are able to open and contribute to different cash and stocks and shares ISAs each tax year. As such there is no limit on the total number of ISAs you hold as part of your previous years' allowances.
In fact it can be a good idea to set up a new ISA every year to ensure that you’re getting a competitive rate on your cash savings and to avoid putting all your eggs in one basket if you are investing in stocks and shares.
What’s the difference between a cash ISA and a stocks and shares ISA?
Until recently ISAs were referred to as Maxi and Mini ISAs. These days, they are simply referred to as cash ISAs and stocks and shares ISAs.
A Cash ISA is much like any other savings account. You can deposit your entire £5,340 allowance in one chunk, or save regularly throughout the year (again, up to a maximum of £5,340).
Like other savings accounts, terms and conditions vary - particularly when it comes to getting your money out, so think carefully about whether you will want to leave your money alone for a year or whether you will need access to it, before you choose the one for you. It is also worth looking at any penalties you might have to pay should you want to transfer your money to another ISA.
Remember that you cannot transfer your ISA yourself by simply closing one account and opening another, as this will mean that your money loses its tax free status. Instead you will need to fill in an ISA transfer form with your new provider and they will arrange to transfer your savings directly from your current Cash ISA account.
An Investment ISA is a tax efficient way to invest in stocks and shares. Like Cash ISAs, they must be operated by an ISA manager to qualify for tax breaks. In most cases, that will be a bank, investment firm or stockbroker, and each ISA will be advertised and sold based on the mix of stocks your money will be invested in – for instance hi tech stocks, small companies or FTSE500 firms.
The decision you need to make here is where you feel most comfortable putting your money, bearing in mind that if shares in the businesses you are investing in go down in value, so will your savings. Most experts agree that Investment ISAs should be longer term investments than cash ISAs, so they are usually not ideal if you may need access to your money within a year or two, possibly longer depending on how the stock market performs.
- Click here for more information on choosing a Cash ISA.
- Click here for more information on stocks and shares/Investment ISAs.
- Click here for more information on transferring money between Cash ISAs.
Which is better?
This largely depends on your circumstances and your attitude to risk.
Investment ISAs carry more risk and more potential reward since they are linked to the stock market – if the market performs well, so will your investment, if it performs badly, you risk losing money.
Cash ISAs are generally more stable, but do not match the potential returns from stocks and shares. Though the rate of interest paid on cash ISAs can go up or down, depending on underlying interest rates (unless you can find an ISA paying a fixed interest rate), the potential for fluctuation is far less than with stocks and shares.
When deciding between a Cash ISA and an Investment ISA, think about:
- Whether you will need to access your money - Investment ISAs are longer term investments, whilst many Cash ISA allow instant access (check terms and conditions for withdrawal penalties)
- How much risk you are prepared to take. Cash ISAs are low risk, whilst Investment ISAs can be moderate to high risk, depending on the funds you will be investing in
Can I withdraw money saved in an ISA?
On the whole, the answer is yes, though how long it will take and whether you will pay any penalties depends on the ISA you invest in.
In the case of a Cash ISA you will not pay any tax on the money you withdraw, though you may lose a month’s interest (check your terms and conditions) or have to wait a month or so if your ISA account required you to give notice before withdrawing funds. Choose an easy-access Cash ISA if you need to be able to access your savings without notice.
You can usually withdraw money from an Investment ISA quickly too, though you need to be careful. Set up fees and administration charges can see the total value of your savings fall at first, before recovering and then growing over time. If you withdraw money at a time when your ISA is worth less you will lose money overall.
Remember also that if you withdraw money from an ISA, having already used your annual allowance, you cannot top it up again later in the year.
- Check your terms and conditions before withdrawing money
- Don’t withdraw money from an ISA if you can help it as it will lose its tax free status and you can’t put it back again until the following tax year
- Check the value of your Investment ISA before taking money out – if it is less than you put in, leave well alone
What’s a self-select ISA?
A self-select ISA is essentially an Investment ISA for experienced investors. Unlike most Investment ISAs, where you simply hand your money over and let the fund manager invest it for you, a self select ISA allows you to make your own investment decisions.
The ISA wrapper still requires a plan manager, but investors can buy into whatever shares or investment funds they like, for instance using a cheap ‘execution-only broker’ or a ‘funds supermarket’ (both are essentially cheap ways to buy shares, if you don’t want or need advice on which ones to buy).
- Consider carefully whether you really know the stock markets well enough to operate a self-select ISA effectively
- Would it really perform better than a straightforward stocks and shares ISA, operated by expert fund managers?
How much tax will I save?
You will not have to pay income tax on your ISA so, depending on whether you pay tax at the basic or higher rate this means that you can increase the interest return on your savings by either 20% (for basic rate tax payers), 40% (for higher rate tax payers) or 50%.
Investment ISAs are slightly more complicated. They are exempt from income and capital gains tax, and interest from fixed interest holdings is tax free. However, any dividend from a stocks and shares ISA is paid AFTER the deduction of tax at 10%.
If you are unsure what your tax position is, speak to your tax office, a financial advisor or accountant.
I’m not a taxpayer - should I still save in an ISA?
Quite simply, yes. First of all, it is worth retaining your ISA allowance in case your tax situation changes. That is, if you have your money in a non-ISA savings account, your interest will be taxed if your non-taxpayer status should change.
Remember also that you are still liable for capital gains tax, even if you do not pay income tax. Putting your money in an ISA will help you to avoid paying it – if your total profit on the sale of an investment is above the capital gains tax threshold (currently £10,100).
With interest rates low and the stock market in turmoil, is it worth the effort?
Again, the answer is yes, ISAs are definitely an option worth considering, at least assuming that you were planning to save or invest anyway.
Interest rates on Cash ISAs might be low at the moment, but they will almost certainly rise again in due course, and if you do not take up your allowance for the year, you will never get it back.
Equally, there is an argument that now is a good time to invest in an Investment ISA. That is, with the stock market currently at or close to record lows, some would say the only way is up. Depending on your attitude to risk, and how much money you have to invest, it may well be worth buying into Investment ISAs since any recovery in the value of shares will be reflected in returns on your ISA investment – buy low, sell high as they say.
Be aware that there is never any guarantee that share prices will go up and that you may have to wait quite some time to realise a return.
Where should I go to start looking for the right ISA for me?
That really depends on whether you opt for a Cash ISA or an Investment ISA.
In the case of a Cash ISA, it is really just a case of looking for the best rates of interest and comparing terms and conditions to select the option that suits you. Think about whether:
- You will need access to your money and how quickly you will need to get your hands on it
- You may want to transfer your money to another provider in the future
- You want the security of a fixed interest rate, or are prepared to risk the rate of interest going up and down
- Check out our Cash ISA comparison tables to compare current cash ISA deals.
In the current climate, we would recommend speaking to a financial advisor before committing to an Investment ISA. However, you can compare current deals here.
