Your top 10 ISA questions answered
Individual savings accounts, or ISAs, were introduced in 1999 to encourage saving and investment. While their tax breaks make them an attractive option, it's important to understand the rules to get the most out of them.
This guide will give you the lowdown on everything from what an ISA is and the different types available to the tax breaks, investment strategies and how to transfer previous ISAs to a new one.
What is an ISA?
An ISA is a tax-efficient savings and investment vehicle. There are two main types - a cash ISA, which is like a savings account offered by banks and building societies and is available to open from age 16; and a stocks and shares ISA, which invests in the stockmarket, either directly into shares or through a collective investment such as a unit trust or investment trust. These are available to anyone over the age of 18.
A self-select ISA is a form of stocks and shares ISA, where you can build your own portfolio from a wide range of investments including funds, shares, gilts (government bonds), bonds and exchange traded funds.
The junior ISA is the new kid on the block. This was announced in October 2010 as a replacement for the child trust fund. Although the details are yet to be finalised, the Treasury announced that it will allow investments in cash and stocks and shares, with the child unable to touch the money until they reach 18.
What are the ISA allowance limits?
Each tax year, there's an ISA allowance you can use for your tax-efficient savings and investments. In the 2011/12 tax year, the allowance is £10,680.
Of this, up to £5,340 can be paid into a cash ISA, with the balance going into a stocks and shares ISA. You can even put the lot into a stocks and shares ISA if you like.
Remember you can't open more than one cash ISA and one stocks and shares ISA each tax year.
What are the benefits?
Whatever type of ISA you plump for, there are a number of tax breaks that will boost your savings and investments.
For cash ISAs, you receive any interest tax-free. With a stocks and shares ISA, you'll benefit from its capital gains tax-free status. Capital gains tax at 18%, or 28% for higher-rate taxpayers, is charged on any gains you make in excess of the annual allowance.
The income tax benefits on a stocks and shares ISA depend on the type of investment you hold. If your money is held in shares that pay dividends, although you won't be able to claim back the 10% tax credit, there's no further tax to pay. While this doesn't benefit basic and non-taxpayers, it does save higher-rate taxpayers from paying a further 22.5% tax on their dividends.
However, even if you're not a taxpayer, it's worth taking advantage of your ISA allowance. You may become a taxpayer in the future, at which point you'll be glad you sheltered your money in a tax-free environment.
4 How do I decide which type of ISA to go for?
Whether you go for a cash ISA, a stocks and shares ISA, or a combination of the two will depend on your financial objectives and attitude to risk.
Unlike a cash ISA, the value of a stocks and shares ISA can go down as well as up. These can rise and fall in value but, over time, the reward for taking this additional risk could be a better return than if you'd put the money in a cash ISA.
It's sensible to avoid a stocks and shares ISA if there's a possibility that you'll need the money in the short term. Ideally, to ensure you don't get caught out by a surprise stockmarket tumble, you need to be able to leave your money in a stocks and shares ISA for at least five years.
5 What does it cost to have an ISA?
This depends on the type of ISA you select. There's no charge on a cash ISA, but you'll pay an initial fee (around 5%) and an annual charge (around 1.5%) on a fund-based stocks and shares ISA, although sometimes the initial fee can be discounted.
With a self-select ISA, you'll need to take into account the dealing costs if you buy shares (these vary from provider to provider, from 1% of the deal to approximately £15, or £7-£8 for frequent trades), plus there may also be an annual administration fee (again, this varies greatly with different providers).
6 How do I top up my ISA?
Topping up an ISA is simple. Providing you haven't already paid in more than the annual allowance, and there aren't any rules to prevent it, you can make an additional payment whenever you like, as long as it's within that tax year - any money put in once the tax year ends will count as if you're opening a new account.
One thing to bear in mind if you have a self-select ISA is the cost of topping up. If you're buying shares you'll be charged a dealing charge each time, so you may prefer to invest larger amounts less frequently rather than drip-feed your ISA.
7 What happens if I take money out of my ISA?
Providing there are no terms and conditions to prevent you withdrawing money, which may be the case on a fixed-rate cash ISA, you can take money out of your ISA whenever you like. The catch, though, is that once you've taken it out, you can't then replace that part of your annual allowance.
Taking money out of an ISA also means you will lose the tax breaks, unless you transfer to another ISA.
8 Can I transfer money from one ISA to another?
If the interest rate or investment performance on your ISA is looking a bit shabby, it's easy to transfer to another provider. Rules are in place regarding how you do this. To keep your tax-free ISA status, never withdraw the money yourself. Contact the new provider and it will oversee the transfer process on your behalf.
While you can transfer part of a previous tax year's ISA, you have to transfer this year's ISA in its entirety. You can also transfer money you've saved in cash ISAs into stocks and shares ISAs. However, it doesn't work the other way around.
9 Should I save regularly or pay in a lump sum?
The answer to this depends on your circumstances. Sticking a lump sum in at the beginning of the tax year will ensure you get the maximum benefit from your allowance. However, many people don't have the readies and prefer to plump for a monthly payment into their ISA.
The good news if you're investing in a stocks and shares ISA on a regular basis is you get to take advantage of 'pound cost averaging'. This means that because your monthly payment will buy different numbers of units each month, depending on their price, when prices are low you'll be able to buy more units.
As an example, say you pay £200 a month into a stocks and shares ISA. In the first month, the price of units is £10, so you buy 20 units. The following month the price has fallen to £8, so you buy 25 units, and in the third month they're back up to £10, so you have another 20.
This would give you 65 units, which at £10 a unit would be worth £650. In comparison, if you'd invested £600 at the beginning, you'd have 60 units, worth £600.
Remember, though, it doesn't always work in your favour. If prices rise steadily you'll end up with fewer units than a lump-sum investor.
10 Is my money protected?
Yes, you're protected under the Financial Services Compensation Scheme (FSCS). If you have a cash ISA with a provider that becomes insolvent, you will be able to claim compensation for the first £85,000. For investments, the limit is slightly lower at £50,000.
Although it's unusual for an ISA provider to go bust, it's sensible to keep your savings and investments with any one firm below the compensation limits.
In addition, the FSCS protection limit is per authorised institution and not per bank; many banks come under the same umbrella, so you should spread your assets.
An example of this is Halifax: if you also hold deposits with Bank of Scotland, Birmingham Midshires, Intelligence Finance, The AA or Saga you will only be covered up to the value of the £85,000 limit, as these are all authorised under the HBOS brand rather than each account being protected for this amount individually.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
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.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
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.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
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.
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.