Our quick rundown explains what ISAs are, how they work and which type might be right for you.
What is an ISA?
Put simply, an Individual Savings Account, or ISA as it’s commonly known, is an account that allows you to save a certain amount of money each year without paying tax on the returns.
ISAs were introduced in April 1999 to replace Personal Equity Plans (PEPs) and Tax Exempt Special Savings Accounts (TESSAs). Unlike standard bank or building society savings accounts, you will never be liable for tax on any interest gained on money saved in an ISA – so they’re a great way ofmaximising the returns on your savings.
Different types of ISA
Cash ISA – Cash ISAs are simply savings accounts where the interest isn't taxed. So if you put money into a Cash ISA (up to your yearly allowance), any gains are yours to keep. Like normal savings accounts, Cash ISAs can either be instant access - allowing you to remove your money whenever – or fixed accounts - which rely on you leaving your money tied up for a set period of time.
Stocks and Shares ISA – This type of ISA invests your money in stocks and shares (such as individual shares or bonds, or pooled investments like investment funds). But unlike traditional investments in the stock market, the gains are tax free. Stocks and Shares ISAs are usually longer-term investments, so your money will be tied up for a set period of time – typically you should be willing to have your money locked away for at least five years. As a result, if you think you may need the money before that time is up, a Stocks and Shares ISA may not be for you.
Warning: Stocks and Shares ISAs are higher risk than those invested in cash, as your returns will depend on the performance of the stock in which your money is invested. This means your investment could go down as well as up, and while investing in equities is often seen as a more reliable inflation-beating method in the long-run, you should be sure that you are happy with the level of risk you are engaging in before investing.
How much can I save?
The current ISA limit is £10,200 per tax year, with a maximum of £5,100 able to be invested in a Cash ISA. So, savers can invest the whole £10,200 into a stocks and shares ISA or split the total equally and save up to £5,100 in a Cash ISA and £5,100 in a Stocks and Shares ISA.
If savers choose to split the annual limit between cash and stocks and shares then ISAs can be held with the same or different providers. But if savers choose to invest the whole annual allowance in a Stocks and Shares ISA, this can only be with one provider during one tax year.
The good news is, every April you’ll get a brand new limit, so you can invest the £10,200 all over again, although the same rules as above apply.
Can I withdraw my money at any time?
As long as your ISA is instant access (and most high-street ISAs are) then, yes, you can withdraw your money whenever you please.
However, it’s important to note that the ISA limit is how much you are allowed to invest over the year in total, regardless of how much you take out. You won’t lose the tax benefits on the rest of your savings by withdrawing, but you won’t be able to re-invest the money during that tax year once it has been taken out of the account.
For example, if you have £2,100 in a Cash ISA at the start of the tax year (6 April) you’re entitled to save another £3,000 until the following 5 April – taking you to the £5,100 limit. But, if you withdraw £1,000 in October, for example - leaving your ISA with £1,100 - then you don’t get to top that ‘lost’ £1,000 up again. So the maximum you could potentially have at the end of the tax year will be £4,100.
In simpler terms, if you invested your maximum limit of £10,200 at the start of the tax year in both stocks and shares and cash, then decided to pull all of your money out half way through the year, you’d have to wait until the next tax year to save anything within your ISAs again.
Do I have to stay with my bank?
No, you can switch provider. But don’t do it by withdrawing your money and taking it to another bank – you’ll lose your ISA limit and tax-free benefits.
Instead, banks can transfer your ISA over to another provider for you. You’ll need to fill in a form and your money will be moved to a new provider for you, to protect your tax-free benefits and any remaining ISA limit, if you move part way through a tax year.
Bear in mind that, if you switch part-way through the tax year, your tax-free allowance won’t change – you’ll still only be able to save up to the £5,100 or £10,200 limit until the start of the next tax year.
What’s next for ISAs?
The current limit is £10,200 per year but it used to be much less – until 2009 the total limit for cash and/or stocks and shares was just £7,200. So you’d only have been able to save £3,600 a year in cash, for example, compared to today’s limit of £5,100.
But from April 2011 the limit will rise even further. In the 2010 Budget, the government announced that ISA limits will now rise in line with inflation. The Retail Price Index (RPI) is the inflation measure, so whatever that sits at each September, that’s how much the ISA limit will rise by in the following tax year.
So, based on the September 2010 RPI figure of 4.6 per cent, next April’s ISA limit will be boosted by £480, taking the overall limit to £10,680.