5 good reasons to open an ISA

There are just two months left until the start of the new tax year on April 6, making now the time to use up this year's ISA allowance, if you haven't already done so.

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You can invest up to £11,280 into an ISA, of which up to £5,640 can be put into a cash ISA. The remaining sum, or even the full £11,280 if you prefer, can be invested in a stocks and shares ISA.

According to our recent MoneySupermarket poll, 52% of you still of you still haven’t used your full ISA allowance for this year – but if you fail to before April 5, you'll never have the opportunity again as it can't be carried over into the next tax year.

But if you're still not sure whether you need a cash ISA, here are five good reasons why you should open one.

1. You can beat the taxman

There are not many circumstances in which you can beat the taxman. But investing in an ISA is one of them.

Unlike a standard savings account, if you save money into a cash ISA, any interest you earn will not be taxed.

For example, on a standard savings account paying an annual equivalent rate (AER) of 2.00%, a basic rate taxpayer (20%) would only receive 1.60%. A higher rate taxpayer (40%) would earn even less at 1.20% and an additional rate taxpayer (50%) would get just 1.00%.

But with a cash ISA all parties would receive the full 2.00% AER.

If you opt for a stocks and shares ISA, any profits from investments are free of Capital Gains Tax (CGT). However, you will pay tax on dividends paid by shares in an ISA as they are automatically taxed at source by 10%.

2. ISAs ARE flexible

Many people mistakenly believe that if you open a cash ISA you have to lock your money away for several years.

But cash ISAs are similar to standard savings accounts in that you can choose between an easy access cash ISA or a fixed rate cash ISA.

Easy access cash ISAs are ideal if you want to get instant access to your money whenever you need it. This means you can also move your money to a better-paying cash ISA at any time – providing your new ISA allows transfers in. Ask your new provider to do this for you so that you don't lose your ISA’s tax-free status.

Do be aware though that if you have paid in your full ISA allowance and then withdraw money, you can’t later top it back up, as you have already used up your allowance.

This also applies to smaller amounts. Let's say you have paid in £5,000 and later withdraw £1,000. You won't now be able to pay that £1,000 back into your ISA because this would take you over your current allowance of £5,640. Instead, you would only be able to pay in £640.

Right now, one of the best paying easy access cash ISAs is the Cheshire Building Society's ISA Saver paying 2.50% AER including a 2.00% bonus until 31 July 2014. Be prepared to move your money to another cash ISA after this period as the interest rate will drop as soon as the bonus expires. The ISA allows you to make as many withdrawals as you need to, penalty-free.

One drawback of the account is that it can only be operated by post. If you'd prefer an online option, the Barclays Loyalty Reward ISA pays 2.28% AER including a 0.25% bonus for 12 months. Again, you can make as many penalty-free withdrawals as you need to. But be aware you must be a Barclays current account holder or have saved at least £500 with the bank to qualify for the ISA.

In theory, if you choose a fixed rate ISA instead, you should earn a higher rate of interest as you will be locking away your money for a year or more. But at the moment, that's not necessarily the case.

The market-leading one-year fixed rate cash ISA is from the Mansfield Building Society, paying only 2.25% AER. And Santander's two-year cash ISA pays 2.50% AER – the same as the Cheshire Building Society easy access cash ISA. However, in this case the interest rate is fixed, not variable.

It's not worth tying up your money for more than two years at the moment as you won't be able to beat the offering from Santander.(That is, unless you have £50,000 to transfer in, in which case the BM Savings three-year fixed-rate ISA pays 2.80% AER. The account is operated by post only.)

For further options, head over to our comparison service.

3. The ISA allowance is going up

From April 6, 2013, you'll be able to keep even more of your savings away from the clutches of the taxman. That's because the annual ISA allowance will rise to £11,520 and again, up to half of this (£5,760) can go into a cash ISA.

But when you pay in your new bigger allowance will also count. If you pay it in on the first day of the new tax year on April 6 (to the Cheshire Building Society’s cash ISA paying 2.50% AER), you will earn £144 in interest over the year. But if you wait until this time next year to pay in your allowance (so on February 6, 2014) you would have earned a measly £23.75 in interest.

You’ll benefit even more if you act now to use this year’s ISA allowance – and then top it up with your new one as soon as the 2013-14 tax year begins.

For example, if you put this tax year's allowance of £5,640 into the same Cheshire cash ISA on Wednesday, February 6, and then paid in your new ISA allowance of £5,760 in two months’ time (on April 6) when the new tax year starts – a year later you would have accumulated £308.84 in interest.

But if you put this year's allowance of £5,640 into the same ISA on February 6 and didn't pay next year's allowance in until February 6, 2014, you would have earned only £188.59 in interest.

4. You don't need a large lump sum to invest

Paying in the full ISA allowance in one lump sum may be more fruitful but it isn't an affordable option for everybody. Fortunately, many cash ISAs will allow you to open them with as little as £1 – the Barclays Loyalty Reward ISA mentioned above is one example. Easy access cash ISAs also allow you to add to your funds whenever you can afford to.

Fixed rate cash ISAs are more restricting, however, as once you have paid in your initial deposit you usually can't make further deposits later on.

5. You can venture into investments

If you have never dabbled in the stock market before and fancy giving it a whirl, a stocks and shares ISA is a great place to start. You can put a range of investments into a stocks and shares ISA including individual company shares, funds holding shares or bonds, investment trusts, open ended investment companies (oeics) and exchange traded funds (ETFs). Head over to our stocks and shares ISA page for more information.

It's a good idea to speak to an Independent Financial Advisor (IFA) first, as he or she should be able to help you to choose the right investments for you. You will need to pay for this advice though.

Remember also that investing is not for the faint-hearted as there is a risk you may not get back as much as you paid in. However, on the flipside, you could get back a much higher return than simply saving into a cash ISA.

Putting away your money for five years or more will help your investments regain any falls that are made.

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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