Breaking the ISA – an introduction to ISAs

by Adam on May 10, 2010

Magical Penny is proud to host this guest-post to help you understand  UK-specific ‘Individual Savings Accounts’, more popularly known as ISAs.

The humble ISA has become more popular in recent years, more so when the base rate dropped to a record low back in March 2009. But how much do any of us really know about ISAs? Do you just see them as a fancy version of savings account, or as the sound investment opportunity they are?

There are essentially two types of ISA. One deals purely with cash deposits and is therefore appropriately named the ‘cash-only ISA’. The other, which I’ll go into more detail about a little later, holds assets such as shares, bonds and equities as well.

The Cash ISA

The cash ISA is perhaps the easiest one to understand as it works similar to a regular savings account. The pros and cons of a cash ISA are outlined below:

+ Can carry a higher rate of interest than a regular account. A typical interest rate on a cash ISA can be between 1% and 4.75%.
+ The money contained within, and interest earned, is tax exempt so you keep all the money you’ve saved.
+ Can prevent impulse buying as in some cases notice needs to be given to the bank before withdrawing your cash.

With some ISA accounts money is locked away for a fixed period of time, so may not be suitable for short-term saving goals.
Can only deposit up to £5,100 per financial year. If you wish to save more look at a stocks and shares ISA instead.
Cannot ‘top up’ during the year if you withdraw early. The £5,100 is the maximum you can deposit in one year, regardless of how much you later withdraw.

The Stocks and Shares ISA

Unlike the cash ISA, the stocks and shares ISA allows you to hold assets as well as money, and has a higher deposit limit of £10,200. Some of the pros and cons of stocks and shares ISAs are listed below:

+ If you’re a higher-rate tax payer, a stocks and shares ISA will allow you to pay less tax on your savings. Typically you would only pay 10% on the interest as opposed to the 40% a higher-rate tax payer would be liable for.
+ If you hold shares or bonds, you can link them to a stocks and shares ISA, meaning any money you make on them would only be liable for the lower rate of tax.
+ As stocks and shares ISAs typically have longer fixed terms, the interest rates tend to be higher than on cash ISAs.

The stocks and shares ISA isn’t suitable for small amounts or short-term investments. If you plan on selling your assets relatively quickly, don’t keep them in this type of ISA as you won’t realise the rewards.
Investing in any type of asset can be risky as the market fluctuates. After your ISA period has ended your return may not be as much as you expected or you could potentially lose your initial investment.

With both types of ISA, there are risks and rewards. As interest rates rise and fall, so will the interest you earn on your savings. Some banks will have a minimum deposit of £1000 to open up an account, but others can set one up for as little as £1. You may need to be an existing customer of the bank before you can open an ISA with them.

An ISA can be an excellent way of providing for your future, much like a pension. If necessary, seek financial advice from a professional before investing in stocks and shares.

Louise Tillotson is a financial author with UK comparison site moneysupermarket.com.



{ 2 comments… read them below or add one }

Kate

I really like the way you have broken down ISA’s with pros and cons. Great article and more informative than many I have read.

SamedayPaydayLoan

ISAs provide munificent tax advantages to everyone in the UK and over the years the government has cut down ISAs considerably, that’s why there is no excuse not to collect the benefits.

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