How To Choose The Right ISA - ISA Basics

An ISA is not actually an investment. It is a tax wrapper, within which you can place certain investments, such as Unit Trusts, shares and cash. The main benefit is that the income and gains from the investments are sheltered from capital gains tax and the growth is free from income tax (although dividend income is taxable, paid by the ISA manager). 

ISAs replaced PEPs (stocks and shares type investments, as well as corporate bonds) and TESSAs (cash based investments) with effect from 6 April 1999.  

In each tax year it is possible to opt for either one “Maxi” ISA where investment is restricted to one provider, or up two “Mini” ISAs where investment in each of the two available options, investment and cash, can be made with a different provider.  

Type                                       Investment limit

Maxi ISA                              Up to £7,000 in a tax year

Mini ISA (Cash)                     Up to £3,000 in a tax year

Mini ISA (Investment)            Up to £4,000 in a tax year

The advantage of the maxi version is that more of your investment can be made into the stocks and shares element. The advantage of mini ISAs is that the most competitive and appropriate provider can be selected for each component.

Income and capital gains from ISAs are free from personal tax and their returns need not be reported on tax forms.  

Dividends from UK companies carry a 10% tax credit which can no longer be reclaimed by ISA managers (since April 2004). However for higher rate taxpayers there is no further tax to pay on share dividends held within an ISA.  

Interest on corporate bonds is paid net of 20% tax and this can be reclaimed by the manager giving corporate bonds a slight tax advantage over equities within an ISA for basic rate taxpayers, especially for those looking for an income. However the actual tax saved will depend upon the returns over the period the ISA is held. 

From 27^th December 2005 the range of investments which can be held in the investment element of ISAs was extended to include certain collective funds investing directly into commercial property, which were previously not available. 

Stakeholder ISAs

Stakeholder ISAs replaced CAT-standard ISA’s from 6^th April 2005. To earn the name ‘stakeholder’ the products have to meet conditions designed to ensure that the products are straightforward and good value.

- You can pay into the account by cheque, direct debit, standing order, direct credit (also called BACS or automated transfer).

- The prices at which units or shares in the fund are bought and sold must be the same and the price should be published daily.

The stakeholder conditions do not guarantee the performance of a product. They do not mean that the government recommends that product or that the product is necessarily suitable for you. But they do provide a useful benchmark against which to compare other products. 

However these standards are not compulsory and in general only some “tracker” funds satisfy the limited charges permitted within the stocks and shares elements. 

Assets held within an ISA can be ignored for the purposes of completing tax returns, however they will form part of your estate for inheritance tax.

Next time we'll look at risk, and what you need to know before you invest.