Get to grips with the details of ISAs

A RECENT survey by Halifax said that 37 per cent of households now have an ISA. But how many of us actually use our full annual allowance or, more to the point, even know what our yearly tax-free entitlement is? And for experienced investors who already put their money to work elsewhere, the paltry returns on an ISA might seem hardly worth bothering about. So with the end of the tax year (5 April) only weeks away, why should we be bothering with an ISA and maximising our annual allocation?

ISAs give tax relief on both income and capital gains tax so investing in products through your ISA will save top-rate taxpayers 40 per cent on income-yielding assets at the moment (scheduled to rise to 50 per cent for those who earn over £150,000) and 18 per cent on capital gains liabilities. Making the most of this is not only rational but also essential for long-term financial planning.

What types of ISAs are there?
The best-known is the cash ISA, as these are the ones that high-street banks tend to promote. However, don’t overlook the stocks and shares ISA, which lets you put money into a range of investments, such as unit trusts, open end investments companies (OEICs), single company shares, as well as government and corporate bonds and are only available to those aged 18 and over. Some stocks and shares ISAs will charge investors.

Is it worth having a cash ISA?
Yes. Although the amounts might seem relatively small, the fact that they are tax-free makes them too good to miss. Anybody aged 16 or over can invest £3,600 a year in a cash ISA. Those aged 50 or over before 5 April can invest £5,100. From 6 April, everybody will be eligible for the £5,100 allowance. Cash ISAs act like savings accounts and the interest is paid tax-free on a monthly or annual basis.

So what is the maximum you can invest?
You can invest in one cash ISA and one stocks and shares ISA per year up to a combined maximum of £7,200 for those under 50 and £10,200 for those 50 and above. You can invest the full £10,200 in a stocks-and-shares ISA but any money contributed to a cash ISA needs to be deducted.

With a stocks and shares ISA, what do you invest in?
Most individuals with a stocks and shares ISA will invest in funds to gain exposure to the stock market. You could put all your money into a single fund, or employ a financial adviser to select the funds to put in to your ISA. More experienced investors can open a self-select ISA where they make the decisions themselves and would buy a portfolio of shares and funds.

ISAs are always advertised as being tax-free, but are they really?
Cash ISAs are, yes, but the picture is a little more complex with stocks and shares ISAs. You won’t have to pay income tax or capital gains tax, but you will still be liable for the dividend tax credit, which is deducted at source. And if you invest in interest-bearing investments such as corporate bonds or commercial property then this interest is also tax-free.