As the end of the tax year approaches, investors must tackle the issue of low savings rates, says Rosie Murray-West
Another year, another Isa allowance. The Government allows everyone to shelter a certain amount of money from the taxman every year, in accounts known as Isas.
However, although it is as important as ever to ensure you take advantage of this tax perk, savers are faced with a conundrum this year.
For those who have traditionally used supersafe savings accounts to stash their Isa cash, the problem is particularly acute. Savings rates on Isas are now so low that the return on your money is struggling to outpace inflation.
This means that even with the tax-efficient allowance given to all savers, if you put your money into a cash Isa it is still likely to lose some of its value in real terms during the next 12 months. The effects of inflation can be significant. The £10,000 you might have invested five years ago, allowing for average interest and tax, would be equivalent to £9,016 today.
Recent figures show that more and more people are looking to the stock market to provide them with the possibility of growth. Experts talk about the "great rotation", which simply means that many people are choosing to move out of funds that invest in bonds and Government debt and are choosing to put their money into the stock market instead.
As someone wanting to maximise your Isa income, you should note that you can put more money into this type of investment than into a cash Isa, while still taking advantage of the tax perks.
The Government has raised the Isa allowance for this year. George Osborne announced in his Autumn Statement in December that he was putting up the total allowance by 2.1pc, to £11,532. You can choose either to put the whole lot into investments or a maximum of half of it into cash and the rest into investments.
So how can you choose the best option for you?
Cash Isas remain an ideal place for short- to medium-term savings, whether you're putting money aside for, say, holidays or a new car, or as protection against difficult economic times.
But investment Isas are also a valuable vehicle for those with longer-term horizons. They can be used for anything from funding future university costs to saving for retirement. The flexibility of these Isas makes them a popular supplement to more traditional pension savings, too.
Whichever type of Isa you choose, remember that this is a "use it or lose it" allowance. If you don't invest the maximum this year you can't carry forward any unused allowance into the next tax year.
With many families still feeling the pinch, it certainly makes sense to utilise the valuable tax breaks offered on these savings plans, so less of your savings and investments ends up in the hands of the taxman.
For cash Isas, the main benefit is that interest paid on your savings isn't taxed. On an ordinary savings account 20pc tax is deducted at source, and higher-rate taxpayers will have to pay a further 20pc (or 30pc if they are in the 50p tax bracket) through a self-assessment tax return.
But with Isas the interest is paid gross (so no tax is deducted) and there is no further tax to pay you don't even have to include details of these accounts on any tax returns, cutting down on paperwork. They are particularly tax-efficient for higher-rate taxpayers compared to conventional savings accounts.
If you have cash Isas from recent years, do not assume that you are still getting a good rate on your money. Many good Isa rates include a bonus, which is removed after a year. So even if you took out a top-paying Isa in the beginning, the rate may have dropped to as low as 0.1pc now. It is relatively easy to transfer these Isas to a new provider details of how to do this are on page 3 of this supplement. You may choose to put this year's allowance into a new account and then transfer your old Isas into it as well. However, not all accounts with good rates allow you to transfer money, so you may wish to open a new Isa as well.
Investment Isas allow savers to avoid capital gains tax (CGT) and most minimise income tax charges although this does depend what assets you have invested in.
But older investors should take note that these investments will be included within your estate for inheritance tax purposes.
In terms of what investments you choose, many experts believe that because of the great rotation, this will be a year for equity funds.
There is some evidence to support this theory, in that more people are choosing to buy shares at present. The FTSE 100 had its best January since 1989, while figures from the Investment Management Association (IMA) in the UK show that equity funds were the best-selling products for the last four months of 2012.
Equity funds are funds that own shares anywhere in the world, and global figures suggest that the same is happening everywhere. Figures from a US-based research group called EPFR show that investors bought $22.2bn of equity funds in the week to January 9, the highest since September 2007.
One of the attractions of buying shares with your Isa allowance, rather than putting the whole lot into cash, is that many shares pay you an income several times a year, called a dividend. In many cases the income, or yield, you can get from shares at the moment is far higher than the interest rate you can get on a savings account.
The FTSE 100, which is the index of the UK's biggest stocks, is currently yielding more than 3pc and this is forecast to rise. Options trading firm Banc de Binary said that the average yield on FTSE 100 (FTSE: ^FTSE - news) companies would rise from 3.07pc to 3.37pc.
The company said the yield would attract struggling savers who cannot find inflation-beating returns anywhere else. Government bonds, for example, yield just 2.05pc for a 10-year gilt, while the average interest rate on an Isa is around 2pc.
If you want to get these returns within an Isa, one way is to invest in an equity income fund, which specialises in shares that produce an income.
When you are choosing where to invest, picking the right fund is key.
Your decision will depend on your own attitude towards risk, as well as your view on the economy.
There are articles in this supplement looking at different areas in the world where you could put your money. It's also important to look at the charges you will pay to the people who manage your money if you want to maximise your gains.
Finally, for the brave among you, we've asked experts in the field to tip an outside-chance fund that could come good this year. They've tipped everything from Japanese funds to Polish and Turkish stocks.
But whether you favour a risky bet or a safe-as-houses cash savings account, the message for all potential Isa applicants is the same: you either make use of your allowance or you lose it.
And in a low-interest- rate and high-inflation environment, few of us can afford to do that.