ISA stands for individual savings account; the term was introduced by the government in 1999 to encourage people to save more by offering tax incentives. ISAs allow people to save their money in a range of investments such as cash, stocks and shares, and life insurance products. Unlike investing directly in these products, investing through an ISA provides certain benefits. An ISA is often referred to as a “tax wrapper” which goes around your savings, protecting them from paying certain taxes.
Am I Eligible?
- If you are aged 16 or over (if you are under 18 you can only invest in a cash ISA. After your 18th birthday you can also invest in a stocks and shares ISA); and
- If you reside in the United Kingdom for tax purposes (or are a Crown employee currently working overseas and treated as resident, or are married to a person who performs such duties);
you may invest in an ISA. You cannot hold an ISA jointly with anyone else, or hold one on behalf of another person.
Types of ISA
There are two types of ISA - cash, and stocks and shares. Each has different limits.
Within the stocks and shares component you can hold investments such as individual stocks and shares, investment products such as authorised unit trusts, open-ended investment companies (OEICs), investment trusts and life insurance products as well as gilts and corporate bonds.
This type of ISA carries more risk because your return is not guaranteed and you may even lose money. Yet the upside is that you may get higher returns over time by taking greater risk with your money and also benefit from the expertise of a fund manager who will make investment decisions on your behalf.
The cash component permits you to hold bank and building society deposit accounts, National Savings and Investment products and investment or insurance products which aim to produce a cash like return e.g. money market funds. The interest rate is also typically higher than that of an ordinary savings account. Like standard savings accounts, cash ISAs offer a choice of easy access options, or others that tie up your money for a specified period in return for a higher rate of interest. And just as with other deposit accounts, up to £50,000 held in a cash ISA would be protected by the Financial Services Compensation Scheme should your bank collapse.
Benefits of investing in ISA
- There are Income Tax and Capital Gains Tax benefits.
- You do not have to declare your ISA on your tax return.
- The ISA manager will either receive income gross of tax or reclaim the savings tax from HM Revenue and Customs on your behalf. You don’t have to do a thing.
Income Tax
- Money held in the cash component of an ISA is entitled to receive income without being charged savings tax.
- Higher rate taxpayers are exempt from paying the extra 25% tax on dividends from equity investments which they would normally pay on investments outside an ISA wrapper.
- Corporate bonds, which pay out fixed interest distributions, held in an ISA are entitled to receive income gross of tax or reclaim the savings tax of 20% (as appropriate).
- Interest paid on cash held temporarily in a stocks and shares ISA will be taxed at a rate of 20%, but higher rate taxpayers will suffer no further tax liability.
Capital Gains Tax
All gains from any investments sold within an ISA are free of Capital Gains Tax (CGT), but it is important to note that any losses cannot be offset against gains made elsewhere.
ISA Allowance - Yearly Limits
Given the tax breaks, it isn’t surprising that the government has limited the sum you can invest in an ISA each tax year. Currently, you can put up to £7,200 a year in an ISA, dividing this sum depending on the kind of assets and risk level you want. For example, you can put the full allowance in the stockmarket, or you may want to hold some of the allowance in cash. However, the maximum sum you can save in a cash ISA is £3,600 a year.
Withdrawel Limits
You can withdraw as much money as you wish from your ISA at any time, subject to the terms of your ISA. However, if you do this and then decide you want to put it back in later in the year, it will count against your normal ISA subscription limits for that year. For example, if you invested £6,000 and withdrew £2,200 you would only be able to put £1,200 back in, as this would bring you up to the maximum limit of £7,200. For investors benefiting from the new £10,200 limit (people aged 50 or over on or before 5 April 2010), if, for example, they invested £8,500 and withdrew £3,000, they would only be allowed to put £1,700 back in.
Set Up Cost
It won't cost you a penny to save through a cash ISA. The only considerations are finding one to suit you with a competitive rate, and deciding how much you want to invest. The minimum deposit is often just £1. However, for a stocks and shares ISA you generally have to pay a one-off set-up fee, which is between 4% and 5%, and there will be an annual charge, of between 1% and 1.5%. Some companies reduce their charges during the ISA season, which runs for a few months before the end of the tax year.
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