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What is an ISA?
Individual Savings Accounts (ISAs) are a form of tax-free shelter or 'wrapper' that replaced Personal Equity Plans (PEPs) and Tax Exempt Special Savings Accounts (TESSAs) in April 1999. Both PEPs and TESSAs remain in force but no new subscriptions can be made to PEPs. Subscriptions can continue to TESSAs up to the normal limits, but reinvestment at maturity must be into an ISA.
Investments held within ISAs are exempt from Income Tax and Capital Gains Tax. The income or gains received from ISAs does not need to be declared to the Inland Revenue.
There is a limit on the amount you can invest each year (see Limits).
There is no minimum holding period for an ISA to retain its tax exempt status. However, you should ask any ISA manager if their product includes penalties or additional charges for early withdrawal, and whether you need to leave your money invested for a minimum period in order to qualify for the best rates, any bonuses or guarantees.
There are two different kinds of ISA (see Mini and Maxi) which can invest in up to three different ISA components, Cash, Stocks and Shares and Insurance (see Types). It is important that you understand the consequences of investing in the different types of ISA as investing just £1 in the wrong type will limit your overall allowances and investment choices.
What are the Investment Limits?
The original proposals were that the maximum that could be invested in any tax year would be £5,000 of which a maximum of £1,000 could be held in cash. As an "introductory offer" this limit was increased to £7,000 for the first year with a maximum of £3,000 being permitted in cash. The Chancellor of the Exchequer announced in the March 2000 budget that this introductory offer would be extended for a further year and then in the Autumn 2000 pre budget speech it was announced that the £7,000 maximum investment limit would be extended for a further five years.
There are restrictions on how much can be subscribed into each component.
Maxi ISA Stocks & Shares £7, 000 total
Mini Cash ISA £3,000
Mini Stocks & Shares £3,000
Insurance ISA £1,000
It should be appreciated that you can only subscribe to one Maxi ISA in a tax year and if you invest in a Maxi ISA you can not also invest in a Mini ISA and vice versa (see Mini and Maxi)
Some ISA providers may set limits on their investments, for example, some may only permit the full £7,000 to be invested into a Maxi ISA. Furthermore, not all ISA providers offer both Maxi and Mini ISAs and not all will offer the different components. Indeed, it is rare to find a provider who offers all three components.
In addition to the above you can also invest the original capital from a maturing TESSA or Follow on TESSA without affecting the above allowances.
To invest in an Individual Savings Account you must be resident and ordinarily resident in the United Kingdom for tax purposes. Or, if not so resident, perform duties which, by virtue of section 132 (4)(a) of the Income and Corporation Taxes Act 1998 (Crown employees serving overseas), are treated as being performed in the United Kingdom, or be married to a person who performs such duties.
Be 18 years of age or over (16 years or over for a Cash Mini ISA)
If investing in a Maxi ISA you must not have subscribed to any other ISA in the same tax year other than a TESSA only ISA.
If investing in a Mini ISA you must not have subscribed to a Maxi ISA or another Mini ISA investing in the same investment component in the current tax year.
There are two different kinds of ISAs, Mini or Maxi, which can invest in the three different investment components or ISA types. These are the Investment Component - known as Stocks and Shares ISAs. This component can be invested in collective investments such as Unit Trusts, Investment Trusts, shares listed on a recognised stock exchange, or bonds and gilts (which are not redeemable within five years from the date of purchase). Cash can also be held within the Investment Component but only pending future investment in any of the above. Interest on cash held in the stocks and shares component will be subject to a flat 20% tax charge. then there is the Cash Component which can be invested in building society deposits, UK or European authorised bank deposits, cash unit trusts or National Savings.
Lastly there is the The Insurance Component. This invests in a life assurance policy on the life of the investor which can also provide supplementary benefits such as critical illness cover. This is the least common component and the majority of policies offered are simple investment contracts where the "life assurance" element is simply 101% of the value of the investment. This may very well be removed frm the ISA regime shortly.
TESSA Only ISAs (TOISAs) typically invest in the Cash Component but do not make up part of an individuals annual ISA subscription allowance.
The maximum an individual can invest in ISAs in a tax year is currently £7,000. This investment could be in a Maxi ISA with one provider, wholly invested in the Stocks and Shares component or in theory spread across all three components (Stocks & Shares, Life Insurance and Cash). Alternatively you can have Mini ISAs from up to three different providers, each investing in different components (Stocks & Shares, Life Insurance and Cash).
It should be appreciated that investing just £1 in the current tax year into any Mini ISA will mean that you cannot invest in a Maxi ISA in the current tax year.
TESSA Only ISAs (TOISAs) are not governed by the Mini and Maxi rules.
If you are unhappy in any way with an ISA held with a provider, you can easily transfer it to another provider. All you need to do is complete a form, which the new provider will supply. They will then arrange for the transfer to take place.
Your existing ISA manager can't stop you transferring, but they may make you pay a charge, or insist that you sell any existing ISA investments and transfer cash (this will be specified in the 'ISA Terms & Conditions'). However, ISA cash, savings and investments must always remain in the same component. You cannot move funds from, say, a 'Cash ISA' with one manager to a 'Stocks & Shares ISA' with another.
If you want to transfer the money you have put into your ISA in the current year, you must transfer all of it. If you do this, any more money you want to put in within the current year must go into the new ISA. You can also transfer some or all of the money you put into your ISA in earlier years. Some managers may not allow you to transfer part of your ISA. Your existing ISA manager will be able to tell you how much you can transfer.
Transferring an ISA will not affect the amount you can contribute in total in the current year.
A TESSA Only ISA is a special low risk ISA which offers a continued tax shelter for the capital element of a maturing TESSA (Tax Exempt Special Savings Account).
The government has introduced some standards for ISAs to help investors choose their investments. CAT stands for Cost, Access and Terms. There are different CAT standards for each component of the ISA and there is no requirement for every ISA to meet the standards.
The key features document issued to investors should clearly state whether or not an ISA has met the CAT Standards. Meeting the standards is not an indication that a particular investment will be good or bad, but simply that it has a certain level of charges and access, and a low minimum investment.
CAT Standards are not a Government endorsement of a product or a guarantee, they do not indicate a superior product - a CAT Standard product may do better or worse than a non-CAT Standard product.
The cash mini-ISA is arguably the easiest component of the ISA regime to understand and is a good way to get tax-free interest without risking your capital. But there are certain things to bear in mind to get the one that best suits your needs.
When they were launched cash ISAs were regarded as a poor relation to their stocks and shares cousin. But today, with stockmarkets still requiring a greater attitude to risk than deposit accounts, the cash ISA is finally getting its day.
"Anyone who's not using their full £7,000 ISA allowance for stocks and shares should definitely consider a cash ISA, even if it's only for short-term savings,” says John Davison, Managing Director of Myers Davison Ginger Ltd. “It doesn't cost anything and, as savings institutions tend to set their cash ISA rate slightly higher than the gross interest rate on their savings account, even non-taxpayers are likely to be better off with an ISA.
The benefits are even clearer for taxpayers. To ensure the buying power of your savings increases, you need it to grow at a rate higher than inflation, currently around 2.9 per cent. For a basic rate taxpayer, this would mean having a savings account with an interest rate of at least 3.63 per cent gross. For higher rate taxpayers the interest rate required is 4.84 per cent gross, something you won't find anymore without having to take some risk with your capital.
This, coupled with the recent poor performance from the stock market lowering confidence, has made the cash mini-ISA increasingly popular in the last couple of years, as Inland Revenue figures demonstrate. In the first year of ISAs (1999/2000) some £12,306 million poured into the cash element compared to £16,054 million for the (then) much sexier stocks and shares version.
However, a couple of years down the line the situation reversed. In the 2001/2002 tax year £17,058 million went to cash ISAs while only £11,319 million was placed in stocks and shares ISAs. And the Revenue's forecasts for last tax year reveal a similar picture with cash ISAs taking twice as much as stocks and shares ISAs (£18,526 million compared with £9,123 million).
If you're considering making your £3,000 part of next year's cash ISA figures, it's important you pick a product that suits your needs. Although the difference between the best and worst is only likely to be a matter of a couple of percentage points, with interest rates and inflation low, every extra penny counts.
When it comes down the nitty gritty – the interest rate – best buy tables offer invaluable assistance, but even armed with these you can be caught out. “Some providers do the old rate trick, luring people in with a high headline rate that they then cut back once they've attracted enough business,” explains John. This little trick means it's important to pay attention to the rate being paid on your cash ISA even after you've opened it – something John recommends doing every six months or so.
Another common trick that allows ISA providers to bump up a rate and secure the top spot in a best buy table is the bonus. These are typically added after you've held an account for six months and are becoming increasingly common.
Look at all the details when choosing between ISAs cautions John. “Many best buys include short term bonuses so, unless you only intend to invest for the length of the bonus period, you might be better off with a plain vanilla account paying a good rate with no restrictions or bonuses.”
Looking at the AER (annual equivalent rate) can help to put these rates into context. This is a notional rate showing the actual interest rate you would receive if you held the ISA for 12 months.
Additionally, assuming rates did not change, the returns on the ISAs with bonuses would slip still further in the second year.
There is one way to take advantage of these short-term bonuses. “Be a rate tart,” says Myers Davison Ginger's John Davison. “The majority of people just put their money into an ISA and leave it; but if you're happy to transfer between ISAs then you can really take advantage of these special bonuses.”
Transferring is easy. There are no limits on the number of times you can do it and it doesn't affect the tax-free status of earlier years' ISA contributions. John further explains. “Your new ISA provider will give you an application form for their ISA which you complete and send off to your current provider. I then shouldn't take more than 30 days to complete the transfer."
But before you dash out to rearrange your cash ISAs, watch out: there can be catches. Unfortunately, not all providers will allow you to transfer your existing ISA to them and some will penalise you if you leave them.
While not being able to move your cash ISA to another provider may be frustrating, it's definitely not as annoying as finding yourself hit with a charge from your existing provider when you transfer. Thankfully the majority don't penalise you for moving and some will only demand a week or more's notice. Others will dock interest, especially if it's a fixed-rate product, but the worst offenders will charge you a fee if you move your ISA money to another provider.
“Don't wait until you want to move before you think about these penalties,” says John. “When you're opening an account or transferring to another provider look out for these exit charges. If you want to transfer again they could easily wipe out any advantage you got from the higher rate.”
Of course the rate isn't everything. As well as looking for the best rates, it's also important you don't lumber yourself with a cash ISA that doesn't do what you want it to do. For starters, it's worth checking the small print if you're not going to put in the maximum £3,000 allowance (or more with all those previous years' contributions you'll want to transfer) as some providers offer tiered rates. For example alender could on its cash ISA pay 3.00 per cent on balances over £10, 3.25 per cent once you've saved £1,000, 4.00 per cent when you've got the full year's allowance in, and 4.25 per cent when you've got more than £9,000 saved.
While this may be annoying, especially as the advertisements will promote the higher rates and leave the lower rates for the small print, some ISA providers aren't even interested unless you've got the full £3,000. This is especially true on the fixed-rate products, although a few of the variable rate ones also set their minimum balance at £3,000.
Another feature that is relatively common on ISAs is a notice period, with about a quarter of them coming with a tie-in of anything from one week to 90 days – or longer if it's a fixed rate bond ISA. But while these products used to bring advantages it seems this has changed. The premium for tying your money up appears to have disappeared, as interest rates have fallen and the instant access products will often offer the same or a better return.
But before you get submerged into fixed rates, bonuses and notice periods it's worth considering whether the cash ISA is your best option. If you have debt such as a credit card balance then, because the interest rate on this will typically be higher than any cash ISA available, it makes sense to pay this off rather than save.
Alternatively, you might think cash is for cowards and that it's the perfect time to jump back into the stockmarket – in which case you might just want to save the full £7,000 allowance for a stocks and shares ISA.
But a final note: many finance gurus always recommend squirreling away three months' net salary in case of emergencies. A cash ISA is as good a place to stash this cash than anywhere else.
<<br /> Tessa-only ISAs
Next March marks the demise of the Tessa, as the final wave of these mature. But to keep the name, and tax-free benefits, alive, Tessa-only ISAs, known affectionately as Toisas, were created. These operate in exactly the same way as cash ISAs, having similar rates and conditions but are only available if you have a maturing Tessa.
The rules on moving to a Toisa are straightforward, with Tessa providers set up to move your money to their Toisa product or, less happily, help you complete the necessary paperwork to move to another provider, but there are some catches. You have exactly six months from the date your Tessa matures to transfer to a Toisa. If you're moving to another provider, make sure you don't take the money out rather than transfer it, as this will make it impossible to open a Toisa with the mone.
There are limits on the amount you can move to a Toisa. The Inland Revenue has restricted it to just the capital (up to the £9,000 maximum contributions limit) so any growth you will have received on your Tessa cannot be moved into a Toisa.
Cash mini ISAs rules
Under the ISA rules investors can place up to £3,000 into a cash ISA in any tax year. Naturally, as with anything controlled by the Inland Revenue, there are conditions attached:
A maximum of £7,000 can be invested into ISAs each tax year, either as up to £7,000 into a stocks and shares ISA or as up to £3,000 in a mini cash ISA, a further £3,000 in a mini stocks and shares ISA and £1,000 into the life assurance component (mainly offered by Friendly Societies).
Investors cannot open maxi and mini ISAs in the same tax year. This means that if you open a stocks and shares only maxi-ISA you will not be able to open a cash mini ISA alongside it. There are exceptions to this. A few maxi ISA managers offer the three different ISA components within the maxi wrapper, so you will still be able to hold cash within a maxi ISA.
Withdrawals cannot be replaced. So if you put the full £3,000 in a cash ISA, then withdraw £1,000 to pay for a holiday or home improvement you can't top your ISA up to the full £3,000 later that tax year.
CAT standards are available for cash ISAs. To qualify for a CAT standard, a cash ISA must have no charges; a minimum investment of £10 or less; no restrictions on withdrawals or payments; a facility to make withdrawals within seven working days or less; and an interest rate no less than two basis points below the base rate.
It's also important to remember that ISAs might not be around forever. When the government introduced them in 1999 it stated that they would run until at least 2009, although it has only committed to the current contribution levels until April 2006 so these may change before 2009.
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