ISAs Guide
An ISA is an Individual Savings Account. It isn’t an investment, but is a tax-exempt wrapper in which you can place your investments - cash, shares, funds and life insurance - to protect them against income and capital gains tax.
When you buy an ISA, you have the choice of either buying:
- The ISA wrapper complete with a pre-assembled parcel of investments within it, or
- Just the ISA wrapper, which you can then fill with your own selection of investments - this is known as a Self Select ISA.
The ISA was first introduced in April 1999 as a replacement for the PEP, or Personal Equity Plan, and the TESSA, or Tax Exempt Special Savings Account. At present the law allows you to put up to £7000 in an ISA each year.
Types of ISA
Just to confuse matters further, there are two basic types of ISA, the Mini- and the Maxi-ISA. In any single tax year, you have to choose either one or the other – you cannot have both:
- The Maxi ISA. You can invest up to £1,000 in life insurance, £3,000 in cash and the balance in shares, up to a total of £7000. Alternatively, you can invest the full £7,000 allowance in shares. You are only allowed 1x Maxi ISA per year.
- The Mini ISA. Again, you can invest up to £1,000 in life insurance and £3,000 in cash. However, you are only allowed to invest a maximum of £3,000 in shares. The difference is that you can open up to 3x Mini peps-and-isas.html'>ISAs each year, one for each type of saving/ investment and use different ISA managers who specialise in each of these types of investment.
- The TESSA Only ISA. A TESSA Only ISA is a leftover from the pre-1999 regime. It is a type of ISA that ONLY allows you to re-invest the capital proceeds from a maturing TESSA. This is of no interest to anyone who does not have existing TESSA savings.
Under the current legislation, you can put a maximum of £7,000 into ISAs each year, either as a single lump sum or staged throughout the year. You can withdraw funds from your ISA at any time without penalty, but you cannot reinvest in your ISA once you have used your £7,000 allowance.
ISA Options
Whilst the current ISA legislation complicates matters with the use of Maxi- and Mini- ISAs, the reality is that for most people the ISA is used in one of four basic ways:
- The Cash ISA. A Cash ISA is basically the same as a bank or building society savings account. You deposit your cash - up to a maximum of £3000 in either a Maxi or Mini ISA - and you receive interest on the sum you have deposited. The only difference is that you don‘t pay tax on the interest.
- The Self-Select ISA. Self-select ISAs are only available for the stocks and shares component of the ISA. You can either choose to buy into a selection of funds, such as Unit Trusts or OEICs, or you can choose to buy a selection of individual shares. This is a highly flexible type of ISA that gives you full control over your savings and investments.
- The Managed Fund ISA. Most fund managers pre-pack their unit trusts, OEICs and investment trusts into a range o ISAs with specific investment objectives, leaving you with a number of choices - capital growth or income? High risk or low risk? UK blue chip or Asian growth stocks? And of course you have to choose which company you want to manage your investment. All of these fund managers will charge you for the privilege of them looking after your money, but choose carefully, some of them are better at it than others!
The Tracker Fund ISA. A tracker fund is one that is set up to mirror the performance of a specific underlying investment - which might be a particular industry sector or stock exchange index. Many tracker funds outperform the majority of the comparable managed funds and because they often have lower running costs, they can represent an excellent diversified investment.
And by putting a tracker fund into an ISA wrapper, you will be benefiting from the performance of the fund without suffering from the demands of the tax man.
ISA Content
There are strict rules about what you are allowed to put into an ISA. You can include the following:
- Stocks & shares: Individual company stocks and shares, unit trusts, OEICs, and investment trusts
- Cash: Bank or building society accounts, National Savings and unit trust cash funs
- Life Insurance: ISA-specific life insurance investment products
Tax Benefits
The only reason for taking out an ISA is to protect your savings and investments from the taxman:
- Income Tax: Cash ISAs are free of income tax. Interest from gilts or corporate bonds is also free of income tax. However, since 6th April 2004 any income from shares or share-based unit trusts is charged 10% income tax at source and this cannot be reclaimed.
- Capital Gains Tax, (CGT): However, there is no capital gains tax to pay on profits made from the sale of any investments held within an ISA.
Before taking out an ISA you should check that the tax benefits outweigh the costs and charges associated with running the ISA. It is possible that you might get better value placing your saving or investments elsewhere.
CAT Standards
CAT is short for Cost, Access and Terms. These CAT standards have been set by the government and are intended to help you identify the more straightforward ISAs that offer a reasonable deal for the private investor.
Firms can choose whether or not to use these standards. Not every ISA complies with the CAT standards but that doesn’t necessarily mean that those that don’t comply are bad products. It may just mean that they are not suitable, or of interest to, every investor.
Similarly, just because a product does have the government CAT standard, these is no guarantee that it will perform any better than a non-CAT marked ISA - even if it does have reduced charges!
