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Find out how you can use your ISA allowance to save £10,680 each year tax free and how you can be sure you have the best ISA deals all year round.
What is an ISA?
As an incentive to save the government provides each UK resident over the age of 16 with a tax free investment allowance every tax year (this runs from 6th April to the 5th April the following year, the latter of which represents the annual ISA deadline). These are known as ISAs (Individual Savings Accounts) and funds can either be invested as cash or in stocks and shares.
How much can you put in an ISA?
For the 2011/12 tax year the total ISA allowance is £10,680, up to £5,340 of which can be saved in a Cash ISA (this is the cash ISA limit) and the remainder in an Investment ISA. This simplified set up replaced the old Mini/Maxi distinction that used to be used for ISA investments.
As part of this simplification, which came into effect on the 6th April 2008, all existing Mini Cash ISAs, TESSA-only ISAs and the cash components of Maxi ISAs became known as Cash ISAs, while PEPs and the stocks and shares components of existing Maxi ISAs became known as Investment ISAs (also known as Stocks and Shares ISAs).
How to secure the best ISA savings rates
Most banks and building societies offer a range of Cash ISA accounts so you have plenty of options when it comes to fnding the best ISA rates.
Cash ISAs operate similarly to ordinary, taxable savings accounts with both fixed term Cash ISAs and instant access Cash ISAs available. The main difference, aside from the ISA rules which make things a little more complicated, is that any interest you earn on your money is paid in full - you don't have any tax deducted whatsoever, unlike ordinary savings accounts.
This tax free interest benefit can make your savings even more profitable providing you keep your money in the best interest rate ISA possible. This means carrying out a Cash ISA comparison at the start of every new tax year to find the best ISA interest rates around so that you make the most of your new ISA limits. However, that's not all you need to do.
Cash ISA providers often reduce the interest rate they pay on ISA savings considerably after the first 6 months to a year. As such even the best ISA accounts can end up paying you minimal interest if you're not careful.
To combat this almost guaranteed decline in even the best ISA interest rates you need to keep an eye on the return your money is earning, carry out an ISA interest rates comparison as soon as you see that the rate has started to drop, and then choose the top ISA available to transfer your savings to.
The exception to this is fixed rate Cash ISAs which will pay a fixed interest rate throughout the agreed term. After this period ends the rate is likely to drop significantly so you will need to look at carrying out an ISA transfer to take advantage of the new ISA rates available. Read our article on ISA transfers for more information.
Cash ISAs tend to be most suited to savers looking for guaranteed returns and those who need access to their money over the short term.
How to compare ISAs for investments
Investment ISAs tend to be more suitable for those looking to invest over a longer period and, as with any investment in the stock market, they do involve an element of risk as returns are dependent on the performance of the stock you invest in. However, it is possible to mediate this risk by spreading your investments using vehicles such as fund ISAs.
When you carry out your Investment ISA comparison it's important to check what you'll be investing in, how much you're able to invest both as a lump sum, and over time and what the ISA manager will charge you in the way of annual management fees and charges if you decide you want to transfer ISA savings to a different provider. Doing so is the only way to make sure you get the best ISA account for your circumstances.
How to understand ISA savings rules
During a tax year you are allowed to invest your Cash ISA and Investment ISA savings allowance with different providers. Although you are only able to pay into a single Cash ISA account (held with a single provider) and a single Investment ISA each tax year. You can however hold different ISA accounts that house previous years’ allowances with a number of different providers.
Any money you invest in an ISA gains its tax-free status immediately so you start to reap the tax-free benefits right away. However, it’s important to remember that after you use your full allowance for a tax year (whether this be the £5,340 cash or £10,670 maximum) you are unable to pay in any more funds even if you make a withdrawal.
Despite this, you can transfer ISAs between providers, although it is vital that you do this by requesting an internal transfer rather than by simply withdrawing the money.
As with previous years’ allowances you are able to transfer funds held in a Cash ISA with one provider to an equivalent Cash ISA held by another provider, similarly with Investment ISAs.
However, as of the 6th April, 2008, you can now convert ISA savings held in Cash ISAs from previous years allowances and money invested under your current year’s Cash ISA allowance, into stocks and shares in an Investment ISA without losing the tax-free benefits.
Whether you decide to use your ISA allowance wholly to invest in the stock market or prefer to have keep some available as cash, the only important thing is that you use as much of it as possible each tax year as ISA allowances don’t roll over, so if you don’t use them, you lose them.
