Your Guide to ISAs

April 6th marks the start of the new ISA season when savers can replenish their existing ISA with its new yearly allowance. And if you don't yet have an ISA, it's also the perfect time to open one and take advantage of this tax-efficient savings vehicle that the government has now committed to stand by for the 'indefinite future'.

2 April 2008

So that's the 'new beginnings' but before we move onto the changes in store for ISAs from this tax year, it's important to understand what ISAs - or Individual Savings Accounts - are, and why they are so beneficial.

An introduction

There are two types of ISAs; a Cash ISA and a Stocks and Shares ISA. ISAs were originally introduced back in 1999 by the then-Chancellor, Gordon Brown. Quite simply, they are a tax-efficient wrapper that is placed around your savings or investments which means that no personal income or capital gains tax is payable.

Cash ISAs

Cash ISAs are by far the most popular and the most simple. For example, if you earn £100 in interest over the year with a Cash ISA, you can pocket the lot. But if this interest is earned on a standard savings account, HM Revenue and Customs will take a slice of any interest earned. So, in this case, most basic rate tax-payers would be left with just £80.

It's hardly surprising then that Cash ISAs have become a highly popular method of saving. According to the Building Societies Association (BSA January 2008), total balances outstanding for Cash ISAs now sits at a cool £141,773 million.

What's more, since the credit crunch broke last summer, Cash ISAs are becoming more popular still as people feel more compelled to 'save for a rainy day'. In January this year, £719 million was deposited into Cash ISAs - more than double the £302 million deposited in January 2007, says the BSA.

Stocks and Shares ISAs

But you can choose to invest in Stocks and Shares ISAs too. These provide you with access to a range of investments including shares, corporate bonds and gilts. The most common Stocks and Shares ISA, also known as the Equity ISA, pools your money together with that of thousands of other investors and is invested on the stock market on your behalf by a fund manager. But if you are confident about playing the stock market yourself, you can also opt for a self-select Stocks and Shares ISA.

Changes for the new tax year

This year however, the government has made a series of changes to both types of ISAs. And the good news is, they are all for the better. So what do canny savers and investors need to know?

  • as you would expect from any tax incentive scheme, the government has placed a cap on the amount you can put into your ISA each tax year. But from 6th April 2008, this cap increases from £7,000 to £7,200. A maximum of £3,600 of this annual allowance can be saved in cash, while the remainder up to £7,200 can be invested into a Stocks and Shares ISA, held with the same or a different provider. Alternatively, individuals can choose to save less in cash and more in stocks and shares - or simply invest the entire £7,200 into a Stocks and Shares ISA.
  • the ISA structure has also undergone a welcome simplification. Prior to this tax year, as well as being split into 'cash' and 'stocks and shares' (previously equity ISAs), ISAs were also categorised as 'mini' and 'maxi'. You could have either two mini ISAs - one in cash and the other in stocks and shares, or one maxi ISA which could hold both cash and stocks and shares. But from this year, the mini and the maxi ISAs, which many people found confusing, will be abolished. Now there are just two types of ISA for your new, improved £7,200 allowance - Cash ISAs and Stocks and Shares ISAs.
  • Personal Equity Plans - more commonly known as PEPS - which were the forerunners of ISAs, will also be scrapped from 6th April. Existing PEPs will become Stocks and Shares ISAs and subject to exactly the same rules and tax breaks, but the balances in these PEPs will not affect your new tax year ISA allowance.
  • also from 6th April, savers will also be able to switch balances held in Cash ISAs, into a Stocks and Shares ISA, which makes it easier to increase your exposure to stock market investments. But if it doesn't work out, bear in mind you can't transfer the money back to a cash ISA.

What's stayed the same?

Several other traits of ISAs have not changed. For example this year, like any other, savers can choose whether to put their fresh allowance into their existing ISA or open a new one. If you decide to top up your current ISA, while the entire balance will remain tax free, each 'slice' of annual allowance will work on the terms set down at the time they were deposited.

And remember, as always, when it comes to your ISA allowance it's a case of 'use it or lose it.' You can't carry any unused allowance into the next tax year.

Finally, the most enduring benefit to ISAs is that it's never too late to take advantage. And if you're still looking for inspiration, a saver who had put away the maximum allowance in a typical Cash ISA every year since 1999, would now be sitting on the handsome sum of £26, 585.59 (Source: Lipper Hindsight 2008).

Changes at a glance

From 6th April 2008:

  • the annual limit for ISAs will be raised to £7,200. Of this allowance, up to £3,600 can be held in cash with the remainder in stocks and shares
  • the concept of mini and maxi ISAs will be abolished
  • PEPS will be abolished and become Stocks and Shares ISAs
  • individuals will be able to transfer money saved in their Cash ISA to their Stocks and Shares ISA