An Individual Savings Account (ISA) is a tax-advantaged means by which investors may save and invest, incurring no income or capital gains taxes on the proceeds. An ISA is not an investment in itself but rather a wrapper to shield your investment - whether it be cash or equities - from being taxable. The tax breaks are on exit, not entry. So there is no tax relief on the money you invest in your ISA, just on the profits; with a cash ISA, for example, the interest you earn will be tax-free. If you sell stocks and shares you hold in an equity ISA, there will be no tax to pay on the profits. However, the tax credit on dividends was abolished a few years ago, so ISAs are not quite as beneficial as they used to be, but they remain advantageous for higher rate taxpayers in particular or for anyone who thinks they may become a higher rate tax payer in the future. They can also be used as part of a long-term financial planning strategy. You could, for example, pay the amount saved in an ISA into a pension later on. A further advantage of investing via an ISA is that many fund managers offer their unit trusts and Oeics with discounted initial charges when they are bought within the ISA wrapper.
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At the moment there are two types of ISA: the mini and maxi. You can't invest in both types during the same tax year. Instead you can either have one maxi ISA, or two mini ISAs (one cash and one equity), which can be with two different ISA providers. A maxi is an account from just one ISA provider split into two components, allowing you to invest up to £3,000 in cash and £4,000 in equities (stocks and shares). Or you can invest the whole £7,000 in the equities component. With a mini ISA, you get a separate account for each component, and you can take each element from a different provider. You can invest £3,000 in cash and £4,000 in equities.
New rules
In the Chancellor's pre-budget report in Novembe 2006, Gordon Brown announced some changes to the ISA rules. These will come into effect in April 2008.
- The potentially confusing distinction between maxi and mini-ISAs is to be abolished though it is likely that the Treasury will retain the current annual investment limits of £7,000 in stocks and shares, or £4,000 in equities and £3,000 in cash.
- The new rules mean that any amount of cash in ISAs from previous years can be transferred into tax-free stocks and-shares holdings without affecting an individual's annual £7,000 savings entitlement. The move aims to encourage people to move into the potentially more lucrative equities component of ISAs. However, you cannot switch back from equity to cash ISAs.
The new rules follow an announcement in which the Government confirmed ISAs were to continue indefinitely, as it is keen to increase the number of people who save money for their futures.
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The old and new rules both effectively mean you can invest £3,000 in a cash ISA and £4,000 in an equity (or stocks and shares) ISA, or the whole £7,000 in an equity ISA. Cash ISAs include bank and building society deposits, and money market unit trusts. Some National Savings products are also included, as well as a range of existing bonds and accounts on which tax is normally payable.
The equity element in an ISA may include any authorised unit or investment trust or open ended investment company (OEIC), as well as any share quoted on a stock exchange recognised by the Inland Revenue. So, what's best, cash or equities? That depends on the investor's attitude to risk and whether they are investing for the short or long term. Equities have the potential for higher returns over the long term and there is the opportunity for growth both in capital and income. They're more risky although risk can be spread by investing in unit and investment trusts. Cash, on the other hand, is more secure if you cannot afford to lose your initial capital and would be worried by stock market volatility. It also offers you access to your money at short notice and so is ideal as a cash emergency fund.
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Most banks and building societies offer cash ISAs, but the terms and conditions differ between products and institutions. For example, some accounts require a minimum deposit when you open the account, or a notice period before you can withdraw the money. Some accounts are run solely online. Rates being offered for savings accounts within a bank or building society's ISA are notably better then those offered by the same institution outside the ISA wrapper. The accounts are generally opened in the same way you would open a normal savings account.
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Equity ISA plans are sold by stockbrokers, IFAs, fund managers, banks and other authorised financial institutions. You can buy a plan and take advice on what to put in it, or you can have a 'self-select' ISA and make your own decisions. Unit Trust and Open Ended Investment Companies (OEIC's) are the most commonly used investment for equity ISAs.
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How much an equity ISA costs depends on the channel you use to buy it. The vast majority of ISAs come with various fees attached. Firstly, the initial fee is payable when you purchase the ISA. On average this ranges from anywhere between 2.5 per cent and 5 per cent. On a £7,000 ISA this equates to £175 to £350. Secondly you'll have to pay an annual management fee which can be anywhere between 0.5 per cent and 2.5 per cent of the total value of your ISA.
Direct
You can buy ISA plans direct from fund managers. Fund managers are the companies that run collective investment funds such as unit trusts, open-ended investment companies (OEICs) and investment trusts. They decide which stocks and shares to buy.
Intermediaries
Buying through an intermediary can be a better option because they give a bigger choice of funds from a number of different fund managers. An intermediary could be a bank, building society, independent financial adviser, broker, investment manager or stockbroker. Some intermediaries offer advice and charge a fee for it. Other intermediaries don't offer personal advice but give instead an execution-only or dealing-only service. These intermediaries are normally discount brokers or fund supermarkets. The discount comes in a reduction or removal of the initial commission, which can be up to 6 per cent. For example, if you invest £7,000 and get a 5 per cent commission rebate, you would be £350 better off. Some intermediaries provide a range of services. Chartwell and BestInvest, for example, both offer an advisory service, have access to a fund supermarket with its own ISA and also have a discount service for investors who know which fund manager's ISA they want to buy.
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If you want to take control of your investment, you might want to consider a self-select ISA. A self-select ISA means taking the existing ISA wrapper and then choosing shares or a combination of funds to shelter within it. You choose from a number of investments from managed funds such as unit trusts, open-ended investment companies (Oeics) and investment trusts, plus individual equities, gilts and bonds. Self-select ISAs are generally sold by stockbrokers, including American Express Investments, Barclays Stockbrokers and The Share Centre. If you buy shares, because you are making the stock choices and completing the deal yourself online, you can trade them at minimal cost. If you buy funds you will have to pay an initial charge of up to 5 per cent although some stockbrokers will offer a discount.
Ongoing commission rebates
Some brokers, such as Chartwell Direct, will also pay direct investors half of the ongoing (trail) commission they receive out of the annual management charge.
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Last Edited February 2007
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