An Individual Savings Account, or ISA, is a tax-sheltered account that can hold a variety of investments, such as cash, stocks, shares, and unit trusts. Interest earned is not subject to income tax and profits are not taxed as capital gains.
This tax treatment and their flexibility in terms of permitted investments have made ISAs perfect for long-term savings. ISAs are also ideal for retirement savings since income on the account is not taxed.
ISAs come in two types: cash and investment, which holds shares and stocks. For the 2011/2012 tax year, the cash ISA limit is £5,340 and the overall limit for the two types combined is £10,680. This means that if an individual invests £5,340 in a cash ISA, he or she is permitted to invest an additional £5,340 in an investment ISA.
The money can be placed with one or multiple ISA managers, which include investment companies, building societies, and banks.
UK residents over age 16 can have a cash ISA and residents over 18 may hold an investment ISA. Both regular, fixed contributions and lump sum deposits are permitted. However, if the annual allowance is not met in one year, it cannot be applied to a subsequent year.
UK taxpayers see the value in these accounts, leading nearly two-thirds of them to invest a total of approximately £350 billion.
With a cash ISA, an individual has quick access to the funds. Though interest rates are at historical lows, a cash ISA is still a better option than an easy-access account, which features a 20 percent tax on interest. Higher-rate taxpayers see even more benefit from investing in ISAs because it helps them avoid an additional 20 or 30 percent tax.
Cash ISAs also usually pay more than easy-access accounts, with the average return being 1.61 percent. According to experts, this is nearly twice the amount of interest offered by a standard account.
Investment ISAs are ideal for individuals who are not saving for things like home deposits and can afford to play funds and shares. When gains from other types of investments exceed £10,100, the tax rate may be 18 or 28 percent, depending on the rate status of the taxpayer.
With an investment ISA, tax is not imposed on profits when the investor sells.
Additional tax is also not imposed on income earned from an investment ISA. Corporate bonds held outside an ISA are taxed at 20, 40, or 50 percent based on the tax status of the individual. Though ISA holders cannot avoid the tax deducted prior to dividend payment, high-rate tax payers will not have to pay an additional 25 percent tax.
Future ISA limits will be tied to the Retail Prices Index (RPI). New RPI figures are released each September and an increase will be applied to the ISA allowance for the subsequent tax year. If the RPS is negative, the ISA allowance will remain unchanged the following year.
With nearly 200 cash ISAs and a wide assortment of investment ISAs to choose from, smart savers have many options.