What is an ISA?

Published:
24 January 2013
Topic:
News,Money,ISA,Savings

Between now and the beginning of April is a crucial time for the nation's savers.

Why? Because this is the window of opportunity left to cash in on our tax-free ISA allowances.

The tax advantages of these kinds of savings accounts make them hands-down the best way for most people to save.

But you'll need to know what an ISA is before you can understand the benefits.

So here is our five-minute guide to everything you need to know about ISAs.

What is an ISA?

What's special about an ISA (which stands for an Individual Savings Account) is that it does not charge tax on the interest you earn. This is up to a certain annual limit which we will come to later.

In technical speak an ISA is a savings account which is held in a tax-free wrapper.

For higher-rate taxpayers, this means avoiding income tax at 40% on any savings interest, while for savers in the basic-rate tax band it provides a saving of 20%.

Those few paying additional rate tax will avoid tax on interest at 50% (though this will fall to 45% from the next tax year).

If you use the stocks and shares part of your ISA (which we will explain later) you will not have to pay Capital Gains Tax on your profits. When it comes to income tax, if you are a higher or an additional rate taxpayer, you will not have to pay those relative top slices of income tax on your dividends.

How much can I pay into an ISA?

For this tax year (up to April 5), the total ISA allowance per adult is £11,280.

You can only put up to £5,640 of this amount into a cash ISA, though.

The remaining £5,640 will have to be invested in an equity or stocks and shares, ISA.

From next tax year, the ISA allowance will increase to a total £11,520 of which £5,760 can be held in cash.

Junior ISAs, which replaced the Child Trust Fund in 2011, can hold up to £3,600 this tax year (going up to £3,720 next tax year) and the money can be split between cash and stocks and shares.

When and how can I invest?

Whether you want to use your full stocks and shares ISA allowance or just your cash allowance, you only have until April 5 to do either for the current 2012/2013 tax year.

You cannot roll it over to the next tax year, so it will be lost forever if you do not.

It is also worth noting that any money paid into your cash ISA and then withdrawn will still count towards your ISA allowance.

So if you paid the maximum £5,640 into your account and then withdraw £1,000, you will not be able to pay any more in before the end of the tax year due to this rule.

What different sorts of ISAs are available?

As long as you stay within the limits described above, you can open one cash ISA, and one stocks and shares ISA each tax year.

As indicated, only up to half of your allowance can be put into a cash ISA. Just like with standard savings accounts, you can choose to take an easy access ISA with a variable rate of interest, or lock in your money for a pre-set term at a (usually) more competitive fixed rate.

For qualifying children, parents can also invest in a Junior ISA that will be free of tax until the child reaches 18 and the money becomes theirs. Bear in mind these accounts are always held in the child's name.

Do I have to split my money between cash and stocks and shares?

You do not have to split your ISA allowance between cash and other assets.

It is possible to invest the full £11,280 allowance in a stocks and shares ISA, within which you can choose the underlying investments - just like with a personal pension, for example.

Assets that can be held in a stocks and shares ISA include unit trusts, investment trusts, open ended investment companies, bonds, individual shares and exchange traded funds.

Remember, though, that while you can move money from a cash ISA into a stocks and shares ISA, you cannot transfer funds from an equity account to a cash one.

Can I switch to a better ISA if I already have one?

It is possible to transfer money invested in previous tax years between both cash and stocks and shares ISAs without losing the tax-free status.

However, you need to be careful not to physically withdraw the funds as this will result in you losing the tax breaks, just as you would if you withdrew a sum of money from the account.

Rather than closing your existing ISA and then looking to move the money into another account, you must therefore arrange a transfer with the provider to which you want to switch.

As not all accounts will accept transfers, this is something to bear in mind when comparing deals, as is the fact that some providers charge exit fees.

In the next few weeks, savings providers will be unveiling their menu of ISA deals as the new tax-year approaches. You can keep abreast of these and shop around for the best deals on MoneySupermarket's ISA channel.

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

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About This Author

Jessica Bown

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Financial journalist

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