Individual Savings Accounts (ISAs)
In some ways, ISAs can be compared to pension plans, because the ISA is just a 'wrapper' around the investments that it contains (just like Personal Pensions that confers special tax privileges that would not be given if the investment funds were bought outside the Pension plan).
Individual savings accounts (ISAs) were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax exempt special savings accounts (TESSAs).
ISAs can consist of up to two investment components:
- The stocks and shares component. This can include virtually all quoted securities, as well as unit trusts, shares in open-ended investment companies (OEICs) and investment trusts. The quoted securities allowed include equities listed on any Recognised Stock Exchange. You can also invest in corporate bonds, as well as government securities issued by a European Economic Area government.
- The cash component. This can be invested in bank or building society deposits and certain money market unit trusts.
No transfers are allowed between these two components
Historically there were two main types of individual savings account - a Mini and a Maxi ISA - but from 06 April 2008 this distinction will be abolished, and there will be just an 'ISA'. The annual Isa investment allowance will be raised to £7,200 (from the previous limit of £7,000) – of which up to £3,600 of that allowance can be saved in cash with one provider. The remainder of the can be invested in stocks and shares with either the same or a different provider. Isa savers will be able to invest in two separate ISAs each tax year - a cash Isa and a stocks and shares Isa.
Under the previous rules, if you put £1 into a mini-Cash ISA, you would only be able to invest £3,600 into a mini-Stocks and Shares ISA. The new rules bring a little more flexibility, as you can now invest, say, £6,000 into the Stocks and Shares Component and £1,200 into the Cash Component.
Mini cash ISAs, Tessa-only ISAs (TOISAs) and the cash component of a maxi ISA will automatically become cash ISAs. ISA savers will be able to transfer money saved in their cash ISA to their stocks and shares Isa. However, this it is not possible to do this reversely; money held in Stocks and Shares ISA cannot be transferred into a cash ISA.
Once you have chosen your Stocks and Shares or Cash ISAs, you may not invest in any other ISA during the tax year
Note: Life insurance funds
Since April 2005 life insurance funds have qualified for stocks and shares ISAs. Previously there was a separate Mini 'life insurance' ISA component in which a maximum of £1,000 could be invested. This caused some confusion at the time, as many people suspected that an insurance-based ISA would naturally provide life insurance cover. What was actually offered was funds provided by Insurance Companies, such as With-Profits funds.
Existing Insurance ISAs can remain in force, but will now be amalgamated within the Stocks and Shares ISA component, though some might qualify for Cash ISA status. Anybody who previously subscribed to an insurance ISA and another ISA of the same component is no longer allowed to contribute to both. ISA rules do not permit investment in two ISAs with different managers if they fall into the same component (although this is rapidly becoming an obscure historical footnote).
Individual savings accounts have several major tax advantages:
- Freedom from capital gains tax.
- Freedom from income tax on interest from corporate bonds and dividends from foreign securities.
- Freedom from income tax on interest earned in the cash component.
It is worth noting that Stocks and Shares ISAs are not entirely 'tax-free', due to the fact that the Government abolished the ability of fund managers to reclaim the tax credit on UK dividend income in 2004. Therefore, there is some merit in holding Corporate Bonds and Gilts within an ISA, as the full 20% tax credit is still reclaimable.
You are free to draw from your plan at any time without adverse tax consequences.
NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.