Personal finance is a complicated world. In my “A Guide To:“ open-ended series, I’ll do my best to break down potentially complicated topics into easily-digestible bite-sized chunks that I hope will remove some of the frustrating complexity or just sheer mystery surrounding a lot of day-to-day finance products.
After each guide, hopefully you will be a little less scared at the mere mention of the topic at hand. If you would like to see a particular guide next, drop me a line.
Today, and the first in the series, I’m going to attack ISA’s.
ISA? TOISA? Mini? Maxi? PEP? TESSA?
Is it any wonder people hear the phrase ‘ISA’ and their eyes glaze over?
Just What is an ISA?
An ISA – or Individual Savings Account – is in simple terms a savings account where you generally don’t pay tax on your interest, nor tax on the sum when you remove it from the account. Anyone looking to save should max out their annual Cash ISA allowances before plunging into regular, standard or alternative savings account types because in doing so the tax man keeps his grubby mitts off your money.
Always a good thing.
What is a Cash ISA?
For once in the world of personal finance, a cash ISA is just what it says on the tin. It’s an Individual Savings Account that you can put cash in.
The current annual allowance is £3,600 and this allowance will increase to £5,100 from April 2010 onwards. The over 50’s have a bit of a head-start on us: their allowance goes up as of October 6 2009.
Think of a Cash ISA as simply a savings account that you do not pay tax on. It’s still just as safe as any other savings account, and is still government-guaranteed up to £50,000 per institution. Your initial investment cannot change or be lost, or eaten up in fees. It’s just a nice clean simple savings account without the tax hit.
For those who have heard the term “Mini ISA”, these are now called “Cash ISA”.
Where Can I Get a Cash ISA?
There is little shortage of options when it comes to choosing a Cash ISA provider. You will need to do your research just like you did for your savings accounts, looking out for the best rates and least lock-ins. Try some of the price comparison websites to begin with (GoCompare, MoneySupermarket, Confused) to get a rough-and-ready look at the going rates, and then go and check the bank websites, too.
Are There Other Types of ISA?
It stands to reason that if there is a Cash ISA, then there must be at least one other kind, and you’re right. There is also the ‘Stocks & Shares ISA’, also less commonly referred to as the Equities ISA. There is one other called a ‘Self-Select Stocks & Shares ISA’ but this is about the same as an Equities ISA, just you can select your own stocks to go in it.
Anyone who has stumbled across the slightly older term “Maxi ISA” will have some idea. A Maxi ISA is now a Stocks & Shares ISA.
Stocks & Shares ISA
This account type lets you put money into a range of investments, such as unit trusts, open-ended investment companies (OEICs – similar to unit trusts) and investment trusts, as well as government and corporate bonds.
Unlike a Cash ISA, this means your investment can go down, as well as up.
A Stocks & Shares ISA also has a different allowance to a simple Cash ISA. You can invest up to £7,200 in the current tax year (2009/10) and if you are over 50, you will be able to invest up to £10,200 in one from October 6.
As with the Cash ISA, those of us under 50 will have to wait for April 2010 to realise the additional allowance.
Unlike a Cash ISA, Stocks & Shares ISA’s are not completely tax-free, either. Buying share-based investments (such as unit trusts and OEICs) through ISA’s saves you tax only if you’re a higher-rate taxpayer, or are likely to pay capital gains tax. However, if you use your Stocks & Shares ISA to invest in interest-bearing investments, like corporate bonds, the interest is tax-free whatever tax band you fall into.
Stocks & Shares ISA’s also have charges that are used to pay commission to financial advisers, cover administration costs, and pay fund managers. These vary, depending on what you invest in, but aren’t usually any higher than those you’d pay if you invested outside an ISA. The key here is to do your homework before choosing which to use.
Self-Select
You can also buy individual shares and put them into an ISA – this is known as a Self-Select Stocks and Shares ISA. It’s really just a sub-type of the Equities ISA, with all the same caveats.
Can I Transfer My ISA Type?
You are able to transfer your previous years’ Cash ISA’s into Stocks & Shares ISA’s without affecting your current year ISA allowance. You can also transfer your current year’s Cash ISA to a Stocks & Shares ISA, provided you transfer the whole amount.
As you may have gathered, you cannot do a transfer the other way around from a Stocks & Shares to Cash.
Can I Transfer My Cash ISA to Another Provider?
Just as you would look to maximise your interest rate in your traditional savings account, you might be tempted to do the same with your Cash ISA as well. You can do this without penalty providing you follow the ISA Transfer Rules which your new provider will help you with. Basically it’s like picking up a cardboard box – not opening it – and taking it to someone else’s house. If you do that, you are fine.
If instead you open your cardboard box, and pack the contents into someone else’s to allow the move, you fail and lose the tax free status of your money.
Analogies out of the way, do not simply withdraw from your old ISA to open the new one. Doing so will nullify the tax free status of the cash you now hold and if you had a considerable sum from many years of ISA’s, you will be in a whole world of hurt.
Can I Only Have One or The other?
You can mix-and-match the types you hold, but your initial investment and savings in a Cash ISA cannot exceed your total allowance when combined. Therefore unless you have a penchant for risk, a 50/50 split is a good idea. This means you can have (at the time of writing) £3,600 in a Cash ISA, and £3,600 in a Stocks & Shares ISA. If you like the idea of a bigger risk for a bigger return, then there is nothing to stop you plunging your entire allowance into a Stocks & Shares ISA (£7,200, again at the time of writing) but you then cannot hold a Cash ISA for the same financial year. Likewise if you wish to hold a Cash ISA, the maximum you can put in it is £3,600. Beyond that your tax-free option would have to then be opening a Stocks & Shares ISA.
It sounds complicated, but it’s really not when you get down to it.
If I Withdraw, Can I Put Back In?
This is the really big difference between a standard savings account and an ISA. You can put money into it up to your annual allowance, and withdraw any or all of the money you put in it.
No problem there.
But once you withdraw a sum, you cannot put it back in. This is important to note because if you need short-term access to money, then this can be a very expensive way of gaining access to it. You are stealing from your future self, in effect. If you have £3,600 in the current financial year’s Cash ISA and withdraw £500 of it, your ISA will close with just £3,100 in it. You can never replace the amount you withdraw.
When Can I Get A New ISA?
New ISA’s can be set up from each April 6th onwards. ISA’s you open in previous tax years get “closed”, i.e. you cannot pay into them any more but they continue to earn nice big tax free sums of interest year on year.
The Stock Market is Too Volatile. Any Options?
If you have maxed out your Cash ISA and still have cash you want to shelter from the tax man in the future but are concerned about market volatility in the present, then you could take advantage of ‘cash parking’ inside a Stocks & Shares ISA. Shrewd Cookie has more information on this.
Pre-ISA Questions
I Invested in a PEP. What Happened?
The ISA was introduced by the Labour Government in 1997 as a replacement for Personal Equity Plans, introduced by ex-Chancellor of the Exchequer Nigel Lawson, as a way to encourage people to invest in the stock market.
The PEP focused on investing in UK-listed companies and the maximum investment was £2,400 per calendar year. If you held a PEP, you still have your investments (stock market performance aside), but you now have a Stocks & Shares ISA instead.
All PEPs were converted during the changeover.
I Had Savings in a TESSA. What Happened?
The TESSA or Tax-Exempt Special Savings Account, was introduced in 1990 by the then Chancellor, John Major, and they were designed to balance the equity-orientated nature of a PEP by allowing investors to invest cash in a TESSA-designated deposit or share account.
Since April 1999 it has been impossible to open a new PEP or TESSA, however, existing accounts could continue. TESSAs had a fixed life on five years and upon maturity could either be cancelled or rolled into an ISA. If you did neither, your account automatically turning into a TOISA, or TESSA-only ISA. In other words, you got to keep your tax exemption irrespective of what you did (or did not) do at the time of maturity, other than if you withdrew the cash.
In Conclusion
More than 17 million Britons have already taken advantage of the tax benefits ISA’s have provided since introduced in 1997. Those who have made full use of their annual allowances every year since then, will have sheltered £79,400 from the tax man!
Have you yet?
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