If you want to invest tax-free, says Emma Simon , it pays to arm yourself with as much knowledge as you can gather
Isas remain one of the UK's most popular types of savings account. It is estimated that more than 20 million people have an Isa, and collectively there is now almost £400bn saved in these tax-free accounts.
But despite their popularity many people are still confused as to how they work, and how much tax they could save.
So if you are new to Isas or if you want to make sure you are make the most of your current Isa holdings we explain some of the key rules and features below.
= What exactly is an Isa? =
Isa stands for Individual Savings Account. Effectively this is just a wrapper, through which you can hold a variety of different types of investment, such as cash, direct shareholding and investment funds. Investing through an Isa is a more tax-efficient way of investing in these assets.
= What type of Isas are there? =
Investors have two basic choices: a cash Isa, or a stocks and shares Isa. The former is simply a tax-efficient deposit account, typically offered by a bank or building society. The name "stocks and share Isa" is perhaps misleading, as they allow investors to invest in far more than just shares. They can also invest in bonds, gilts (Government-backed bonds) commercial property, commodities (such as gold or oil) and shares listed on overseas stock markets.
= How much can I save in an Isa? =
This year you can invest a maximum of £11,280 into an Isa, although only half of this (£5,640) can be invested in a cash Isa.
This is a "use it or lose it" allowance, so if you don't maximise your Isa savings this year you won't be allowed to rollover any unused allowance. However, you will have a new Isa allowance after April, which will be marginally more generous. So between April 2013 and April 2014 you will be able to save £11,520 in an Isa, or £5,760 in a cash Isa.
= How many Isas can I invest in? =
One stocks and share Isa, and one cash Isa in any one tax year. To open an account you will need to give your national insurance details, which will be sent to HM Revenue & Customs. If they notice you have already applied for an Isa in that tax year, the application will be rejected. However, you can still transfer existing Isas, and this won't count towards your current annual limit.
= What are the tax breaks? =
A cash Isa is basically a tax-efficient savings account. On a normal bank or building society account, interest is paid after 20pc tax has been deducted. Higher rate taxpayers are required pay a further 20pc (30pc if they are in the 50p tax band) on the interest. But with a cash Isa, interest is paid gross, and there is no further tax to pay. The main tax-advantage of a stocks and share Isa is that you avoid capital gains tax.
But this tax break is useful for those who build substantial Isa portfolios and hold them over long periods of time.
Stocks and share Isas can also mean you pay less income tax on share dividends, though they are not tax-free. This is because Isa investors can no longer claim back the 10pc tax credit on dividends. This is deducted at source, so for basic-rate taxpayers the income tax paid is the same as if this was a "non-Isa" fund.
There is some advantage for higher-rate taxpayers, though: provided these shares (or a fund paying an income from share dividends) is held within an Isa they don't have an additional tax to pay on this income, as there would be if this investment was held outside an Isa.
However, those who invest in fixed-income funds including all bond and gilt funds will pay less income tax, and this advantage extends to basic-rate taxpayers. This is because no income tax has to be paid on this income stream.
Incidentally, Isas are not exempt from inheritance tax.
= Can I transfer Isas? =
Yes. If you are unhappy with either the rate being paid on a cash Isa or the performance of your stocks and shares Isa, it is possible to transfer it to a new manager without losing the tax break.
= Can I access funds at any time? =
Isas are certainly a lot less restrictive than pensions, which don't allow any access to funds until at least your 55th birthday. Given the current economic uncertainty, it's not hard to see why this flexibility is a good selling point.
However, it is important to check the terms and conditions of each account before opening as they can vary.
Cash Isas are designed primarily for shorter-term savings, but don't assume that you have instant access to your money. The most competitive deals today will require savers to lock their money away for at least a year, some for five.
Stocks and share Isas don't usually have explicit restrictions on withdrawals. But given the volatile nature of stock markets bond markets, too it's only advisable to invest in such assets if you can afford to leave this money for at least five years. This should put you in a better position to ride out the ups and downs of the market.
Those investing in more specialist areas should note that most fund managers reserve the right to impose restrictions should markets crash.
= Do I have to invest the maximum amount in one go? =
No. Most Isa managers will allow either a lump-sum investment, or a monthly payment. This can be particularly useful for those worried about sudden market falls. Given the weight of money that is often invested in the run up to the end of the tax year, it is not uncommon for markets to rise strongly in February and March and suffer a small setback in April.
Similarly, if you wanted to utilise the maximum Isa allowance this year, but were worried about stock market valuations, you could keep this in a "cash fund" and gradually move it into the market.
Don't expect a decent return on these cash funds in the interim, though.
= Can I run my own Isa fund? =
Most people buy funds investing in assets, although it is possible to be your own fund manager and hold shares, bonds, cash or Exchange Traded Funds (ETF) directly if you buy a self-select stocks and share Isa from a stockbroker. These typically charge an annual plan fee and often a set-up fee. There are usually dealing charges to buy and sell stocks, but you do not pay an annual fee to a fund manager.
= Must I include my ISA details on a tax self-assessment form? =
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