The ISA is a vastly underrated yet useful tool for saving money, allowing account holders to invest up to £15,000 tax-free or at a reduced rate. Although it has come to be perceived as something incredibly complicated, well beyond the comprehension of the ordinary layman, its complexity is overstated. This has led many to miss out on the opportunities that ISAs present. To make sure that you’re not one of them, read on to find out more.
ISAs are a tax-free or tax-efficient form of savings or investment account. Those who take advantage of them are rewarded with increased returns on their wealth, as they are charged a lower tax threshold or no tax at all, on the value of their account.
One of the simplest ways to understand ISAs is to use the cake analogy. Imagine that each year you bake a cake (your savings) for when the taxman comes to tea. Ordinarily, the taxman takes the bits he wants, and you’re too polite to hold back the slices you want to keep for yourself. An ISA is the bank’s version of a cake tin. Once you have the tin, you can keep back a select number of slices (up to £15,000 in cash or shares) to save for later, which the taxman cannot touch.
So how much can you keep aside in your cake tin? The current figure stands at £15,000 per annum. As tax years run from April to April, you can invest anything up to this figure during this year long period, split as you like between cash and shares. Your balance resets at the beginning of every year, with any unused allowance becoming void rather than rolling over.
Many people assume that the cash and shares protected by an ISA are only granted these privileges for a year. However, this is not the case at all. Any money invested in an ISA will continue to benefit from the associated rewards for as long as it remains untouched.
Over time, this means that the financially savvy can invest significant sums, often entirely tax-free. The amount that can be invested can change year-on-year, but this means that, had you started invested in 1999, you could now be earning tax free or reduced tax interest on an amount up to £135,880.
Types of ISAs
There are two types of ISAs: cash and investment, and slightly different rules apply to each.
Cash ISAs are not taxed for any savings. This saves account owners a significant sum of money: a standard savings account will pay anywhere between 20 and 45 per cent of the interest they earn to the government, whereas an ISA owner will pay nothing.
ISAs are also available for investment purposes, and can be used to sink your money into shares and bonds. Although these accounts are not entirely tax-free, account owners do not pay tax on profits or interest earned through bonds, and there is a 10 per cent tax cap on income.
As of 2014, your £15,000 allowance can be split between the two in any way you like, whether that means a cash only ISA, investment only ISA or a mix of the two, such as the Modular ISA offered by James Hay Partnership.
Do your research to discover which type would work best for you.