An ISA represents a relatively simple way for the private investor to save in a tax efficient way. Whilst the tool is a relatively straight forward one, there are a number of considerations which will allow the investor to gain the most from an ISA.
What is an ISA
ISAs were introduced by the UK government in 1999 to replace Personal Equity Plans (PEPs) and Tax Exempt Special Savings Accounts (TESSAs) as way of helping savers to save in a tax efficient way. The ISA is best thought of, not as a separate product but as a wrapper, which is put around an investment in order to save tax.
Previously a number of ISA's were available including mini and maxi ISAs, these distinctions have now been done away with and there are just two kinds of ISA available. Current forms include a Cash ISA and a Stocks and Shares ISA. At present an investor may have up to two ISA providers, one for the cash component and one for the stocks and shares component.
Cash ISAs are linked to a standard savings account of which there are a bewildering array of products available. The main feature however, of the cash ISA is that the saver will not have to pay taxes on the interest which they earn during the period. As a product which is linked to a cash based savings account, cash ISA's are also seen as relatively risk free, although one should consider that no investment is completely risk free.
Stocks and Shares ISA's on the other hand, allow the investor to place funds in a range of market linked products from stocks and shares and unit trusts, to bonds and actively managed funds. Here the investor benefits from a number of tax efficiencies, saving money on both dividends and capital gains tax. Whilst the stocks and shares ISA is a tax efficient vehicle for investment, one should consider that this in no way reduces the risk associated with a product. In short, the risk taken in investing in a stocks and shares ISA will reflect the risk of the underlying assets invested in.
How do ISA Allowances Work - Cash and Stocks and Shares Limits
In considering the allowances for investment in an ISA or a number of ISA’s, there is both an overall limit and a component limit. In the tax year 2010 the average investor has an overall limit of £10,200 for investment in ISA related products. At present the full allowance may be used to invest in a stocks and shares ISA, whilst the cash component is capped at £5,100. The key to remember is that the total amount can not exceed the overall limit of £10,200. For example, if an investor places £5,100 in a cash ISA then the allowance available to invest in a stocks and shares ISA is reduced to £5,100.
Allowances are calculated on an annual basis and consider the amount of money invested in the given period. If a withdrawal is made during a period, this amount of money does not reduce the invested amount. For instance, if the full limit of £10,200 has been invested and a withdrawal of £1,000 is made, the investor must still wait until the next year before a further investment may be made under the ISA wrapper.
Ben Groves - Ben Groves graduated from the University of Abertay, Dundee in 2003 with a 2:1 in Business with Economics. Since graduation Ben has held a ...
