ISAs are a good option for investors as they carry an annual tax-efficient allowance. The following guide will look at some of the key points to consider when choosing the best ISA for your individual needs.

ISA Newbie

If you’ve just started looking at ISAs, bear in mind that there are three types of ISA:

1. Stocks and Shares ISA – an account to hold investment funds and/or shares, with an annual ISA allowance of £10,680 per person per year

2. Cash ISA – fixed interest savings accounts; allowance of £5,340 which is half of your total ISA allowance

3. Junior ISA – similar to Cash and Stocks and Shares ISAs – Junior ISA is a new tax efficient savings account designed for adults to help children save and invest for their future. The annual allowance is £3,600 per child per year

Your eligibility to invest in an ISA will depend on individual circumstances, and all tax rules may change in the future.

ISA benefits

Key considerations for taxpayers at all rates – how much tax could you save?

Interest from savings:

•   if you pay tax at the basic rate, outside an ISA you would usually pay 20 per cent tax (2011-12) on your savings interest
•   if you pay tax at the higher rate, outside an ISA you would usually pay tax at 40 per cent on your savings interest
•   if you pay tax at the additional rate, outside an ISA you would usually pay tax at 50 per cent on your savings interest
•   if you pay the ‘saving rate’ of tax for savings, outside an ISA you would pay tax at 10 per cent on your savings interest

Dividend income:

•   if you’re a basic rate taxpayer inside or outside an ISA you pay tax at 10 per cent on dividend income; this is taken as a ‘tax credit’ before you receive the dividend and cannot be refunded for ISA investments
•   if you’re a higher or additional rate taxpayer you would normally pay tax on dividend income at 32.5 per cent or 42.5 per cent; in an ISA you won’t get back the 10 per cent dividend tax credit element of this, but you will save by not having to pay any further tax

No Capital Gains Tax to pay

There is no Capital Gains Tax (CGT) on your ISAs, so it is good to know that no matter how much you invest in the future or how successful your investments are, you won’t have to pay this tax. Bear in mind that it is not unreasonable to expect a £50 monthly savings plan to generate a lump sum of more than £16,000 over 18 years* – this type of investment could very easily attract CGT if not held inside an ISA. And do also remember that the value of an investment can go down as well as up and you may get back less than you invested.

* Assuming a 6 annualised rate of return on a fund with 1% initial charge and 1.5% annual management fee and 2% inflation, the return would be £16,592 over 18 years. These figures are only illustrative and are in no way guaranteed.

Instant Access to Cash

Experts generally agree that ISAs can be most beneficial when they’re used as long-term savings vehicles, although many investors like to know they can also have a nest egg to dip into during emergencies. If you want instant access to cash, a stocks and shares ISA may not be suitable.

Transferring funds between ISAs

So, can I transfer the monies I have invested in my stocks and shares ISA to a cash ISA? No; current rules only facilitate moving monies saved in a cash ISA to a stocks and shares ISA but not the other way around. But you can transfer your cash ISA to a stocks and shares ISA in exactly the same way as you would transfer your ISA to another provider

Mixed Pot

It’s hard to predict the course that rates will take, so as an option, consider spreading your savings; put some into a cash ISA, some into a Stocks and Shares ISA, some into bonds. That way, you’ll never take too huge a risk with all your money. Please remember, the value of investments can go down as well as up and you may get back less than you invested.

Conclusion

Finding the best ISAs boils down to what kind of saver you are. If you’re the type who wants to find a rate you’re happy, a Cash ISA may be best. But if you’re an avid and savvy saver, who keeps a constant eye on market rates, a Stocks and Shares ISA may be more suitable.

About the Author: Malcolm Anderson is an independent journalist writing about retirement options.