A beginner's guide to ISAs
Harriet Meyer answers six commonly-asked questions about the ins and outs of saving in Individual Savings Accounts.
What is an ISA and who is eligible?
An ISA is a tax-efficient "wrapper" in which savers can hold cash or investments. As a starting point for money you're setting aside, these accounts make a sound choice, as any interest earned on savings and any capital gains made on investments within them are tax-free. There are two different types of ISA: cash and a stocks and shares version.
Cash ISAs: A cash ISA is basically a bank or building society savings account, with the difference that it enables you to earn interest tax-free. There are several types of cash ISAs available from banks and building societies, including instant access, fixed-rate, and regular savings accounts.
Stocks and shares ISAs: The second type of ISA - stocks and shares - can hold a range of funds, individual shares, as well as government bonds and corporate bonds. This type of ISA carries more risk because your return isn't guaranteed and you may even lose money. However, the upside is that, historically, you are likely to achieve higher returns than cash over the long term.
Higher-rate taxpayers also get income tax benefits from a stocks and shares ISA because they don't have to pay tax on any dividends they earn. If they haven't got an ISA wrapper they would have to pay 32.5% dividend tax, bar the initial 10% tax deducted. Basic-rate taxpayers, however, pay the same 10% rate in or out of an ISA.
If you want to open a stocks and shares ISA you have to be aged 18 or over, whereas you can open a cash ISA when you turn 16. You also have to be resident in the UK for tax purposes, and you cannot hold an ISA jointly with, or on behalf of, anyone else.
What are the annual limits?
Each of us has an ISA allowance every tax year, but if you don't use it before 5 April each tax year, you lose it. For this tax year (2014/2015), you can set aside up to £15,000.
How much will an ISA cost me?
You don't have to pay anything to open a cash ISA - the only thing you need to consider is to find one with a competitive interest rate. Many cash ISAs come with bonuses that expire after a year, so make sure to move your money.
For a stocks and shares ISA you generally have to pay a set-up fee and an annual charge. The best way to buy investments in an ISA wrapper is through a fund supermarket or discount broker. These offer a range of products with discounted initial and annual fund charges, making it much cheaper to invest.
Some companies also reduce their rates in the run up to the end of the tax year. Websites such as candidmoney.co.uk can point you in the right direction.
My cash ISA rate's dropped. Can I transfer to another ISA?
Many ISA accounts will accept transfers in, which means you can move your money without losing the tax-break. But be aware, if you close your existing ISA without using a transfer form and then look to move the money into another account you will lose the tax-break. While you can't switch from stocks and shares to cash - unless you close the account and lose the ISA benefits - you can move money from a cash ISA into a stocks and shares ISA.
Is there an ISA for kids?
Yes, there is. In November 2011, the government launched Junior ISAs, or JISAs, to replace the child trust fund (CTF), which was abolished earlier that year. Like regular ISAs, there are cash and investment JISAs to choose between. The annual allowance is £4,000. Children under the age of 18 are eligible to open one as long as they haven't already got a CTF.
Can I move my investment into an ISA?
If you hold shares or funds in an investment account, you can sell them and reinvest the proceeds in an ISA. This is known as "Bed & ISA". This way you use existing money or investments to take advantage of annual tax allowances rather than having to find new money, which may not be available.
You have to use this route as you cannot transfer existing holdings directly into your ISA. The holdings must be sold in one transaction, and then brought back in another, using an ISA. There are likely to be transaction costs involved so seek advice before proceeding.
Edited 28 October 2014.
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