Updated on 10 June 2015.
An ISA (individual savings account) is an individual allowance enabling you to save up to £15,000 a year free from income and capital gains tax, maximising the interest you earn on your investment.
ISAs were introduced as a replacement for PEPs and TESSAs in 1999 and have been guaranteed to run in their current form indefinitely.
ISAs are available to all UK residents over the age of 16 (although you must be over 18 to invest in a stocks and shares ISA component).
Additionally, Crown employees working overseas but paid by the British Government (i.e. military personnel or diplomats) are also eligible for an ISA allowance, as are their spouses and families.
However, as they are an individual tax allowance, ISAs must be opened and run by a specific individual and cannot be held in joint names or as a trustee account.
ISAs are commonly referred to as 'wrappers', protecting a certain amount of your savings from tax. You can choose to use your ISA allowance to invest in either a cash component, a stocks and shares component, or a combination of the two, potentially accumulating an extra 20% interest on your investment if you're a basic rate tax payer and more if you usually pay tax at a higher rate.
The cash component of your ISA allowance enables you to save up to £15,240 this financial year in a cash-based savings account without having any tax deducted from the interest your savings accumulate.
Like cash, the stocks and shares component of your ISA allowance enables you to invest up to a maximum of £15,240 each financial year in individual stocks and shares or in unit or investment trusts (less any amount invested as cash).
When you use this component to invest, any capital growth on your assets will be completely tax free. What's more, you will not be required to pay tax on any dividends you receive.
Prior to 6th April 2008 there were two different types of ISAs, Maxi and Mini.
Mini ISAs were made up of 2 components; a £3,000 cash allowance and a £4,000 stocks and shares allowance, each of which could be taken from a different financial provider.
Maxi ISAs were more flexible as while they allowed you to invest up to £3,000 in a cash component, they enable you to invest up to your whole £7,000 allowance in stocks and shares if you wished.
However, to make ISAs more accessible this distinction has now been scrapped and, as of 6th April 2008, the complicated Mini/Maxi system was replaced with a far simpler scheme.
Additionally, from this April date, existing mini cash ISAs, TESSA-only ISAs and the cash component of maxi ISAs automatically became 'Cash ISAs', while mini stocks and shares ISAs, the stocks and shares components of maxi ISAs and PEPs automatically became 'Investment ISAs'.
Now, following rule changes on 1st July, 2014, savers have the flexibility to invest up to £15,240 in a cash ISA or stocks and shares ISA this tax year, it's really as simple as that.
What's more, you are now also able to transfer any funds saved in a cash ISA into a stocks and shares ISA and vice versa without penalty, under the old scheme this was not possible.
It is possible to save up to £15,240 this tax year in a Cash ISA or stocks and shares ISA.
Your £15,240 ISA allowance until the 5th April 2015, after which you will be given a new allowance.
While any money you invest in an ISA during one financial year will uphold its tax free status indefinitely, any unused allowance will not be rolled over. This means if you don't use your full tax-free ISA allowance, you lose it.
Once you've invested money in an ISA it gains its tax-free status immediately and does not lose this benefit once you decide to withdraw it. However, once you've paid in your full allowance during a tax year you're not able to invest anything further under your ISA 'wrapper', even if you've made withdrawals.
The type of Cash ISA you open will depend on how often, if at all, you'll need to access your deposited money. If you'll need to access your money then choosing a Cash ISA that offers instant/easy access is a must. Alternatively, if you're willing to tie up your money for a number of months or even years then a fixed term option may be more profitable as they tend to offer better returns.
Some prefer to deposit one single lump sum and leave it to accrue interest throughout the tax year. Or, you may like to make several small deposits regularly; either way, this will impact what kind of Cash ISA you choose. Consider too how much you will wish to deposit at a time, as some providers have minimum and maximum thresholds in place.
You should check if there's a minimum deposit that must be made in order to qualify for this rate, then decide whether or not you are prepared to deposit this amount. Some providers offer a much higher rate if you are depositing larger amounts of money.
If you're planning to open your account with money transferred from an existing Cash ISA, this will influence which provider you choose. Some providers don't allow you to open a new account with money transferred from an existing ISA. Alternatively, you may simply want to invest new money into the Cash ISA in the future tax year, in which case you'll be able to pick from a wider selection of providers.
Many Cash ISA providers place restrictions on how and when you can access your money. So, when you look for a new Cash ISA it's really important to check whether you will be penalised for making withdrawals (there may be a charge or interest penalty, or you may be required to give a certain amount of notice).
You should also check whether you'll be able to transfer the money in your Cash ISA to an account with another ISA provider without penalty.
Making sure you get the best rate of interest possible is obviously important in maximising your tax free returns. You have the option of choosing an account with an interest rate that is variable (and liable to fall at the provider's discretion), one that is inflated by an introductory bonus for a number of months, or one that stays fixed for a period of time.
If you choose an account with a variable interest rate you'll need to make sure you check the return frequently and move your money when the return is no longer competitive. If it's an account with an interest rate that's boosted by an introductory bonus you'll need to make a note to move your money when the rate drops. The same applies to an account with a fixed rate/term interest rate.
Written by Hannah at money.co.uk
ISAs are a great way of getting more from your money, but with the tax man looking over your shoulder you have to play by certain rules in your quest to avoid plummeting interest rates. Here are your ISA transfer questions answered.
Saving up to buy your first property can be difficult, but a new Help to Buy ISA for first time buyers could soon make it a little easier. We explain how it will work and how it could help you get your new home sooner.
Soon you will have much more freedom when you save in a cash ISA after George Osborne announced the introduction on a new flexible ISA. So what are Flexible ISAs, and how does it differ from the current rules?
95% of savers will no longer have to pay tax on their interest after George Osborne unveiled a new personal savings allowance in the 2015 budget. We examine if this change helps you, and how much extra you will earn.
Can you transfer an ISA and open a new one in the same year?
How the Help to Buy ISA can get you on the property ladder
What are flexible ISAs?
What is your new tax-free personal savings allowance?
Can You Transfer a Child Trust Fund to a Junior ISA?
How do ISA limits work?
What is a NISA?
NISA: Your new and improved ISA
Are stocks & shares ISAs safe?
What are Investment ISAs?
Get expert tips that will help you spend and save smarter, even if you're short on time.