Understanding ISAs: A Beginner’s Guide

When it comes to ISAs, lots of people have a very limited understanding of what they are and how they work. There is a perception that they’re incredibly complex, and this means that many people avoid them or only take them out on the advice of financial advisors. In truth, ISAs are relatively simple to understand and can be a very useful tool when it comes to saving money.

Take a look at our quick guide to find out more. 

What is an ISA? 

At its core, an ISA is simply a tax-free or tax-efficient savings or investment account. It helps you to increase your returns as you pay less tax, or no tax at all if you have cash savings. Think of it like this. The capital and shares you own are biscuits. Each year, when the taxman comes to tea, you plate them up and he chooses the biscuits he wants to eat. ISAs are like a biscuit tin. To encourage savings, the bank gives you the tin to put some of the biscuits away in for later. The taxman can only choose what’s on the plate and cannot touch what’s in the tin i.e. your cash and shares.

How Much Can You Put into an ISA? 

ISA allowances reset each year, with a tax year running from April to April. You can save up to £15,000 per annum, split however you wish between cash and shares.

The money must be invested by the 5th April to count for that year. Any allowance that has not been used becomes void as opposed to rolling over.

How Long Will the Money Remain Tax-Free? 

Savings or investments placed within an ISA wrapper continue to earn interest and benefit from tax rewards until the money is withdrawn from the account. This means that you can invest substantial amounts tax-free over a period of time. For example, as of 2014, an individual could have invested £7,000 per year between 1999 and 2008, £7,200 between 2009 and 2010, £10,200 for the year 2010/2011, and £10,680, £11,280, £11,520 and £15,000 respectively for the years following that. Provided they have not withdrawn any money, they will be earning interest or investment returns and paying little to no tax for these sums.

What’s the Difference Between a Cash and an Investment ISA? 

There are two types of ISA: cash and investment.

A standard savings account will require the taxpayer to give between 20 and 45 per cent of the interest they earn to the government. Those who choose a cash ISA benefit from paying absolutely no tax on their savings.

ISAs can also be used for investment purposes. These accounts are known as stocks and shares ISAs. You can choose to invest in shares and bonds through them. This carries three main advantages:

  1. You will not be required to pay tax on profits.
  2. There is no tax to be paid on interest earned through bonds.
  3. There is a 10 per cent tax cap on your income.

Unlike a cash ISA, stocks and shares ISAs tend to be managed through a broker or some form of fund management entity, such as Killik & Co.

Although this does, of course, carry many advantages not available to ordinary investing, a risk remains that your investments may fall as well as increase. It is recommended that investment ISAs are best suited to those playing the long game – five years at least.

Whoever you are, if you have savings or investments an ISA is almost certainly worth your while. However, the ISA that you should choose – whether cash or investment – is entirely down to the individual and their attitude to risk. The gain from cash ISAs is simple; no tax. Investments are far riskier but do offer a greater reward. Therefore it is imperative that before you choose an ISA, you do your research and work out which type is best for you.