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Individual Savings Accounts

Individual Savings Accounts (ISAs) are the UK government's way of promoting saving. They are tax-free or tax-efficient and available to all UK residents over the age of 16. They are very easy to set up with any of the major banks, either online or in person. Because ISAs are the main method of tax-free saving, they come with investment limits which apply across a financial year (6th April - 5th April). The minimum opening balance is usually only £1 for a cash ISA and a saver can either invest their entire allowance in one go, regularly, or at their own convenience (the rules may be slightly different for stocks and shares ISAs).

There are two types: cash ISAs and stocks and shares ISAs. It is possible to invest in both types during the same year, but not two or more accounts of the same type. If you were born before 5th April 1960, your annual total investment limit is £10200; if you were born after that date it is £7200. This will change from the start of the financial year 2010-11, so that the limit will be £10200 for all. Only £5100 of that £10200 can be invested in a cash ISA, however, and until that change occurs for the under-50s, in April 2010, the limit per cash ISA is £3600 per year. The full allowance can be invested in one stocks and shares ISA.

An investor in ISAs has a choice therefore: in any financial year they can either split their allowance between a stocks and shares ISA and a cash ISA, invest up to £3600 (later £5100) in a cash ISA alone, or invest up to £7200 in a stocks and shares ISA.

It is important to note that the allowances are absolute: even if a saver withdraws money from their ISA, the allowance does not change or recognise that withdrawal. If you have deposited £2000 in one cash ISA, you are allowed to deposit a further £1600 that same financial year. If you withdraw £1000, you will still only be allowed to invest a further £1600.

Interest rates for cash ISAs are generally 1% or so above market rates. The ISA provider will move their ISA interest rates as the Bank of England changes the base rate. However, some banks will offer different deals, such as higher rates of interest for online-only ISAs. It is worth comparing the different cash ISAs run by the major banks before making your decision.

The stocks and shares ISAs are very different from their cash counterparts. The saver's money is invested with a range of products, including government bonds and unit trusts. Because the ISA depends on the performances of these products, the value of the saver's investment can fall as well as rise. It is possible to get back less than you put in. In addition, investors pay charges. These will often be in the range of 1-1.5% of the value of the fund. Stocks and shares ISAs are sometimes described as "tax-efficient" rather than tax-free because some tax is paid on investments. There are different ways of investing: a saver can either invest in an ISA where the stocks and trusts are chosen by the bank, or they can choose themselves which products their money is placed with.

As these depend on the performance of the stock market, they are a longer-term type of investment than the cash-ISA and a bank will often advise you to keep a stocks and shares ISA for up to five years to benefit from it. Returns are difficult to predict and depend on the package you invest with, as well as the market. It is possible for a stocks and shares ISA, when the markets are healthy, to give £3000 after five years from an initial investment of £1000.

The UK government periodically reviews the structure and allowance limits of ISAs, so these are liable to change.