Are you keen to take advantage of tax-free savings, but not sure where to start? If so, check out our simple guide to ISAs.
Individual Savings Accounts (ISAs) were launched by the government in 1999 and allow Brits to save a certain amount of money tax free every year.
With most other types of savings, basic rate taxpayers pay 20% on their returns, which increases to 40% for those in the higher bracket and 50% for people paying the top rate.
In the current tax year which ends on 5 April, it’s possible to invest up to £10,680 into ISAs – £5,340 as cash and £5,340 as stock and shares. Alternatively, savers can invest the entire £10,680 as a stocks and shares ISA.
Cash ISAs
A cash ISA is similar to an ordinary savings account but investors receive 100% of the interest from their money, rather than paying a portion to the taxman.
During the current tax year, anyone over the age of 16 can invest up to £5,340 in an adult cash ISA – set to increase to £5,640 from 6 April.
Cash ISAs can either come with a fixed or variable rate of interest. If an account is variable rate, the return can either rise or fall in line with factors such as the Bank of England Base Rate.
What if I need to make a withdrawal?
As soon as a saver takes money out of an ISA, it loses its tax-free status and can’t be reinvested as part of the year’s ISA allowance.
Some cash ISAs require savers to lock their money away for a number of years – any withdrawals may be penalised with a loss of interest.
Money in existing ISAs
Savers with money in existing ISAs may be able to switch to another product or provider in order to get a more competitive return on their money.
Often cash ISAs come with attractive bonus rates that disappear after a year – should this happen, it may make sense to shop around for a new product.
Although many ISAs accept transfers, a number of the most competitive products are only available to new ISA money.
What are the most competitive cash ISAs?
Savers with at least £1,000 could consider Cheshire Building Society’s Direct Cash ISA, which pays 3.06% gross AER.
However, the return will drop to 1% after 30 September 2013 – at which point it may be prudent to find another savings option.
For those with smaller amounts to invest, Virgin Money’s Easy Access Cash E-ISA pays 2.85% gross AER and has a minimum deposit of £1. In another plus point, this account allows transfers from existing ISAs.
Stocks and shares ISAs
Savers who have used their full cash allowance can also invest £5,340 in a stocks and shares ISA during the current tax year. Alternatively, it’s possible to place the entire £10,680 allowance into a stocks and shares ISA.
Stocks and shares ISAs allow savers to invest in the stockmarket, with any growth from this investment being tax-free – although dividends may be taxable.
With a stocks and shares ISA, there could be annual charges to cover the cost of a stock broker to manage the fund. In addition, there could be charges for buying and selling shares, inactivity fees and charges when setting up the fund.
Because the markets are volatile, stocks and shares ISAs are inherently riskier than cash ISAs.
What’s all this about junior ISAs?
In November 2011, the government launched the junior ISA, which allows parents and other adults to invest on a child’s behalf. During the 2011/12 tax year, there is an investment limit of £3,600 and, like their adult equivalents, these can be either cash or stocks and shares.
Although the money held in these accounts belongs to the child, he or she can’t make a withdrawal until the age of 18.
Nationwide’s Smart Junior ISA pays 3% gross AER on deposits above £1 until 31 October 2013 – after which the rate drops to 2.1% gross AER.
With Skipton Building Society, savers can receive 3% gross AER on savings of above £1. Note, however, these accounts must be opened in one of the building’s society branches.