Individual Savings Accounts ISAs - A Guide

How Individual Savings Accounts ISAs work. What is the difference between a Cash ISA and a Stocks and Shares ISA? How you may invest in cash and or stocks and shares in an ISA and how much you may invest in an Individual Savings Account.

What is an ISA?

An Individual Savings Account ISA is a tax-advantaged means by which investors may save and invest without incurring income or capital gains taxes on the proceeds. An ISA is not an investment in itself. So it is not appropriate to say "I've invested in an ISA" or "What is the best-performing ISA" What you should think is "What can I invest in using the ISA wrapper?"

What can I invest inside the ISA wrapper?

You may invest in a combination of the following types of asset cash deposits, stocks and shares and life assurance investments.

Cash deposits qualifying investments include bank and building society deposits and money market unit trusts. Some National Savings products are also included as well as a range of existing bonds and accounts on which tax is normally payable.

Stocks and Shares - The equity element in an ISA may include any authorised unit or investment trust or open ended investment company OEIC as well as any share quoted on a stock exchange recognised by the Inland Revenue.

You are also allowed to include direct holdings of gilts bought with at least five years to go to maturity. There are no global investment restrictions. So you could invest your full annual allowance in a fund that invests in the US Europe or global technology stocks.

Life assurance investments such as with profits bonds and unit-linked life insurance funds are eligible. Until 5 April 2005 these life assurance products were treated as a separate ISA element. Now depending on the product they form part of either a Cash ISA or a Stocks and Shares ISA.

What are the tax benefits?

An ISA will allow you to invest up to £7200 on a tax-efficient basis each year. There is no tax relief on money put into ISAs on entry unlike contributions to a pension scheme. Instead you are not liable to pay income or capital gains tax on the proceeds of an ISA and the investments you hold within an ISA grow largely free of income and capital gains tax.

However Stocks and Shares ISA investment managers may not reclaim the 10% tax credit on dividend income. This acts to reduce the attractiveness of equity investments within ISAs to basic rate taxpayers. There remains an income tax incentive for higher rate taxpayers who have no further income tax liability on dividends received on ISA investments. Interest from deposits and from corporate bonds attracts a 20% tax credit.

Stocks and shares investments held within ISAs are not liable for capital gains tax.

What are the ISA investment rules?

Despite the Governments intention of making ISAs user-friendly from the outset the rules were extremely confusing! However a number steps have been taken over the years to simplify them and although it has taken almost a decade ISAs are now relatively simple to understand.

There are two types of ISA Cash ISAs and Stocks and Shares ISAs both of which may also contain a life assurance element depending on how HM Revenue & Customs classifies the particular policy.

A Cash ISA allows you to save up to up to £3600 per tax year tax-free with one provider. The remainder of the £7200 annual allowance may be invested in a Stocks and Shares ISA with the same or a different provider.

A Stocks and Shares ISA allows you to invest up to £7200 per tax year. If you do have a Cash ISA in the same year any funds saved in your Cash ISA will reduce the amount you may invest in your Stocks and Shares ISA. For example if you save £1000 in a Cash ISA you may invest only up to £6200 in a Stocks and Shares ISA.

You may switch your current year Cash ISA savings into your Stocks and Shares ISA. However such transfers must be the whole amount saved in that tax year in the Cash ISA up to the date of transfer. You may then invest up to the remaining balance of the £7200 ISA investment limit in your Stocks and Shares ISA or you may save up to £3600 in a new Cash ISA.

These transfer rules make a Cash ISA where no tax is charged on interest unlike ordinary bank and building society accounts a useful short-term parking place for funds you may wish to invest in the stock market at a later date.

You may transfer all or part of previous years Cash ISA savings into a Stocks and Shares ISA without affecting your annual ISA allowance.

Although you may transfer funds in a Cash ISA into a Stocks and Shares ISA you may NOT transfer investments in a Stocks and Shares ISA into a Cash ISA.

How young can I start investing in an ISA?

Anyone over the age of 16 may have a Cash ISA and save up to £3600 each tax year but you may not invest in a Stocks and Shares ISA until the age of 18. This still means you could build a potential £7200 of tax free investment before the age of 18.

Can I transfer my ISA to another provider?

You may transfer your ISA to another ISA manager whenever you wish. You can usually transfer simply by asking the new ISA manager to arrange the transfer. Your existing ISA manager cannot stop you transferring but they may make you pay a charge or insist that you sell any existing ISA investments and transfer cash.

You cannot transfer your ISA by closing it and opening a new ISA with the new ISA manager. You may transfer all of the money you put into your ISA in earlier years or only some of it if you wish. However some managers may not allow you to transfer part of your ISA this will be in the terms and conditions.

If for instance you invested your maximum annual allowance with one provider but decided you wanted to change to another in the same tax year you must transfer all the funds you have already invested to the new provider. However if the transfer costs £50 and the net proceeds of investment with the original provider is £6000 - despite the fact that you invested £7200 - you could only invest £5950 with the new provider.

If you are considering switching to another ISA provider check with your existing ISA provider first to see what if any costs they impose as well as checking on whether they impose a charge for the transfer itself. The important thing to do is to focus on what you want rather than leaping at the first attractive-sounding product that comes along.

What do Stakeholder ISAs look like?

Stakeholder ISAs abide by standards set by the Government and were introduced to provide investors with access to low-cost "risk-controlled" savings products. A Stakeholder cash deposit product will

• Pay interest at a rate no lower than base rate minus 1
• Have a £10 minimum subscription level
• Allow for unlimited withdrawals
• Offer free transfers between accounts and providers

A Stakeholder medium-term investment product may be either a life assurance contract or a collective investment. It can be treated as an ISA and will

• Have an annual charge capped at 1.5 for the first 10 years and 1 thereafter
• Be "unitised" units can be created when new people buy into a fund or deleted when they sell up with unit prices published daily
• Have a £20 minimum subscription level
• Have a maximum of 60 invested in equities and property
• Be diversified across a range of different asset classes markets sectors securities
• Allow for free transfers between accounts and providers

Do bear in mind that just because an ISA product may be described as a Stakeholder product that does not mean that it is approved nor its performance guaranteed by the Government.

What do ISAs cost?

In many cases an ISA will cost no more than the charges of the investments held within it. Many providers such as fund management groups banks and insurance companies regard ISAs as such good selling opportunities that they effectively subsidise the cost of administering these accounts.

It is also the case that fund management groups will sometimes make the cost of investing in their stocks and shares ISAs cheaper than if you invested in the same fund but without the ISA wrapper. So a unit trust management group may levy a 5 initial charge on a unit trust bought outside its ISA while the same fund investing in the same stocks and shares can be bought within the same managers ISA wrapper for 3.

Similarly with regard to the cash element investors may find that the rates being offered for savings accounts within the bank or building societys ISA are notably better then those offered by the same institution outside the ISA wrapper.

2009-03-09 16:12:16 © Moneyextra.com