Individual Savings Accounts (ISAs) are products that allow tax-free investment into cash, funds and equities and should make up an essential part of every portfolio.There are two types of ISA: a cash ISA, in which, unsurprisingly, you can hold cash, and a stocks and shares ISA, through which you can buy funds or individual company stocks.
What are the tax benefits?
Investors are usually liable for capital gains tax on any returns they make when they sell their funds, which will be either 18 per cent or 28 per cent of the gains depending on the tax band into which they fall.
Most people will only pay capital gains tax if they make more than £11,100 profit on their investments in a single year, but ISA holdings do not contribute to this amount.
Furthermore, any income received from ISA investments is not taxed any further. Income is usually taxed at the same rate as your salary.
A cash ISA protects your savings from the income tax that is deducted at source by the taxman on your bank account, meaning that it is effectively a savings account with better interest rates.
How much can I invest?
In the 2015/2016 tax year, you can invest up to £15,240 in the tax-free wrappers. You can invest this in a cash ISA, an investment ISA or a combination of the two.
How do I choose a cash ISA?
The key consideration with a cash ISA is the interest rate, which can vary between providers, meaning that it is important to shop around.
Some of the best rates are available on deals that require you to lock your money in for a lengthy period of time or give a notice period when you want to make any withdrawals.
This makes it especially important to carefully consider how much you want to invest. You need to decide what access you need to the money.
You may want to drip-feed money in regularly to your ISA if you are not sure you are going to need it.
How do I choose a stocks and shares ISA?
As far as stocks and shares ISAs are concerned, charges replace interest rates as the key figures to consider.
Certain providers will offer advice or other services which will cost more, while others will offer a simple execution-only service, whereby they simply provide the means for you to buy funds that you choose.
Can I switch money between products or take it out?
If you take your money out of an ISA during the year then it will still count towards your limit and you will lose the tax advantages on it.
It is possible to switch to another product, however, but it is difficult, and not all ISAs will accept transfers.
You should make sure that the provider switches the fund to avoid losing the tax breaks by taking the money out.
Once the tax year is done, your money remains in the ISA until you choose to take it out, at which point it loses its tax breaks.
However, you can shift money saved in previous years from ISA to ISA – switching provider – without losing the breaks.
When is the deadline?
The tax year ends on 5 April every year and you must use all of your allowance by that date or lose it. In the run-up to that date, some of the biggest ISA and fund providers market their products more heavily.
However, you are not limited in your choice to funds from the biggest providers; many of the best-performing funds do not appear on the buy-lists because they receive less marketing attention.
The table below shows the best-performing funds since ISAs were first introduced (correct to 19 March 2014).
| Fund | Returns (%) |
|---|---|
| Marlborough Special Situations | 1,520.49 |
| Artemis UK Smaller Companies | 882.1 |
| Investec UK Smaller Companies | 788.1 |
| BlackRock UK Smaller Companies | 736.41 |
| First State Asia Pacific | 692.44 |
Source: FE Analytics