Four steps to the perfect ISA
1. The basics
It's possible to invest the full £10,200 in a stocks and shares ISA instead of splitting it between cash and shares; however, you can't invest more than £5,100 in a cash ISA.
Your yearly limit runs from April to April, in line with the tax year, and the deadline for this tax year is 6 April 2011. From this date the ISA limit will also change, increasing in line with the retail prices index each year.
2. The benefits
Any interest you earn on your cash ISA is tax-free.
For stocks and shares ISAs, it's a bit more complicated, but there is no further tax to pay on dividend income and any gains made if you sell your investment aren't subject to capital gains tax. Additionally, you don't have to include your ISA details on your personal tax return.
Read our round-up of the best cash ISA rates
3. How to pick an ISA
There are plenty of different products to choose from. With cash ISAs, you should decide whether you want instant access to your money or you're happy to lock it away for a set period in a fixed rate ISA.
Fixed-rate ISAs tend to be slightly higher than instant-access ones, although you will need to pay in a lump sum, whereas you can make smaller regular payments into an instant-access ISA.
More care is needed with stocks and shares ISAs. A self-select ISA does what it says on the tin and is only for people with some investment experience.
Otherwise, pick an ISA that offers a variety of funds. An independent financial adviser can help you find one that suits your attitude to risk and investment goals. A more low-cost option is to use a fund supermarket.
4. Chase the rates
Keep an eye on cash ISA rates. If the interest rate becomes uncompetitive, you can transfer to a better-performing one.
Don't just withdraw your money from one account to pay into another, as your money will lose its tax-free status and be treated as a new subscription for 2010; ask the new provider or ISA manager to arrange the transfer.
Remember: some ISAs won't accept transfers and others charge for the service.
NOTE: you can't open more than one cash and one stocks and shares ISA in any tax year.
Sometimes known as a trading ISA, a self-select ISA gives investors full control over which assets to include in their ISA, allowing them to choose individual shares and bonds rather than investment funds. Aimed mainly at experienced investors and subject to the same investment limits of a regular ISA, a self-select ISA will usually be managed by a stockbroker on an investor’s behalf.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.