Updated on 19 May 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.
Written by Hannah at money.co.uk
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