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.
FE Trustnet outlines the benefits of investing in each type of ISA, as well as a few things to look out for.
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.
However, most people will only pay capital gains tax if they make more than £10,600 of profits on their investments in a single year. 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.
This means anyone not investing through an ISA could be throwing away money to which they are entitled.
This year you can invest up to £11,280 in the tax-free wrappers, half of which can be in a cash ISA; however, you can put the full amount into a stocks and shares ISA. The allowances are set to increase in line with inflation in future years.
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.
Higher interest rates
Rates on cash ISAs 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.
Kerry Nelson (pictured), managing director of Nexus IFA, said: "You need to decide what access you need to the money. Should you use the whole allowance or are you going to need some of the money quite soon?"
"You must remember that you lose the tax advantages if you take it out of a cash ISA during the year. It is possible to switch to another product, however, but it is difficult." "In terms of a cash ISA, it’s about the interest rate you are going to achieve. Looking at last year’s best-sellers list is the best place to start your research."
Nelson points out that with base interest rates paid by the Bank of England currently so low, the rates on offer may not be particularly attractive.
Many products have variable rates that will rise when the base rate rises. However, this will not necessarily help to protect against inflation.
The retail price index stood at 3 per cent in November 2012, according to the Office for National Statistics, meaning that any cash ISA offering less than that is effectively guarding your money while it shrinks in value.
The best rate we could find, following a quick search on the internet, was 3.1 per cent, with all other accounts offering less than 3 per cent.
This is likely to appeal most to those who do not want the hassle of picking funds or shares, and have a low tolerance for risk, rather than those who are looking for returns.
Fees and charges
As far as stocks and shares ISAs are concerned, Nelson says that charges replace interest rates as the key figures to watch out for.
"The provider you choose will depend on whether you want to seek advice or buy online as execution only," she said.
Nelson recommends that investors who are not sure how much they can spare should get into the habit of dripping money into a fund on a monthly basis.
"At the end of the tax year you can then see what you have got and decide if you want to use up your allowance."
Once the tax year is done, the money remains in the ISA until you choose to take it out, at which point it loses its tax breaks.
However, you can continue to shift money saved in previous years from ISA to ISA – switching provider – without losing the breaks.
The tax year ends on 5 April every year, which means that 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.
This weekend FE Trustnet will be considering some lesser-known funds and trusts that have good track records.