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What is an ISA?

ISAs fall into both the 'Savings' and 'Investments' category, because there are different types of them.

ISA is short for Individual Savings Account and is a form of savings account which was introduced by the Government in the late 1990s. An ISA is not actually a product but a tax wrapper around an investment or savings product. It protects your interest from being subject to tax.

Each UK adult may place a certain amount of money into an ISA in any one tax year (April to April), the two main types are:

  • Investment (or Stocks and Shares) ISA
  • Cash ISA

You may have both ISAs with one provider, or two separate providers. You may use your entire ISA allowance for an Investment ISA, or you may use the money for both types. You may not place the entire allowance amount into a Cash ISA.

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Who can have an ISA?

For a Cash ISA you must be aged 16 or over and for an Investment ISA you must be aged 18 or over. You must be a full UK resident (and accordingly, be under UK tax law) and in general you must also live in the UK.

There are some special variations to this rule: people who work overseas but are paid by the UK Government (such as diplomats, members of the armed forces or Crown employees) and their spouses/civil partners may open an ISA.

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What is an Investment or Stocks and Shares ISA?

An Investment ISA (sometimes referred to as a Stocks and Shares ISA) allows you to invest in long-term investments – such as bonds, pooled investments or individual shares. There are two limits according to age group for an investment ISA (although this is set to change, see note below), and they are:

  • Under 50s

People under the age of 50 receive a limit of £7,200. You may choose to place the entire allowance into an Investment ISA.

If you wish to do so, you may place up to £3,600 of that amount may be saved in cash with one provider. The rest may be used for an investment ISA with the same provider or a separate provider.

  • 50 and over

Those aged 50 and over receive a limit of £10,200. You may choose to place the entire allowance into an Investment ISA.

If you wish to do so, you may place up to £5,100 of that amount can be saved in cash with one provider. The rest may be used for an investment ISA with the same provider or a separate provider.

Please note: from 6 April 2010, the limit will change to £10,200 for everyone. In other words, those aged under 50 will receive the same limit for cash and investment ISAs as is currently only offered to those aged 50 and over.

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What is a Cash ISA?

A Cash ISA is very similar to a regular savings account offered by a bank or building society, but for one key difference: the interest paid in a Cash ISA is paid gross of tax instead of net of tax. This gives you a higher return.

Each tax year (April 6th to April 5th), an investor is permitted to put £3,600 (from April 2010 this will increase to £5,100) into a Cash ISA. Once the investor has filled a Cash ISA with that amount, he or she is not permitted to add any more.

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What is the Cash ISA Allowance?

Cash ISAs carry a limit per tax year. Like Investment ISAs, the limit alters according to your age group, though this is set to change (see note below):

  • Under 50s

People under the age of 50 receive a limit (or allowance) of £3,600.

  • 50 and over

Those aged 50 and over receive a limit (or allowance) of £5,100.

Please note: from April 2010, the limit will increase for under 50s – they will also receive a limit of £5,100.

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How to Use your Allowances

As you can combine your ISA allowance into Cash and Investments, you could use your limit as follows (assuming you have the under 50s current allowance):

  • Use the entire £7,200 for Investment (such as shares) – leaving nothing for Cash
  • Place £2,000 in a Cash ISA and the rest into an Investment ISA
  • Half-half: £3,600 for Cash and the remaining £3,600 for Investment

Clearly, when the allowance changes from April 2010, everyone will have more money to share between ISAs. You do not have to use the entire allowance and can place smaller amounts in Investment, Cash or both types of ISAs.

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Where can I Apply for an ISA?

You can apply for an ISA from an ISA manager – this includes banks, building societies, insurance companies, unit and investment trust companies, stockbrokers, National Savings and Investments, some supermarkets and retailers, financial advisers and fund supermarkets.

Not every ISA manager will offer both Cash and Investment ISAs. For instance, you cannot get a Cash ISA from a stockbroker. Your ISA manager will look after your account for you.

  • If you require an Investment ISA

Investment ISAs are usually available from stockbrokers, unit and investment trust companies, insurance companies and financial advisers.

In order to get the best for your capital, make sure you browse and shop around to find a suitable ISA manager. For instance, some providers may offer to spread risk by setting up a regular contributions scheme. This allows you to spread costs and risk over the year.

  • If you require a Cash ISA

Cash ISAs are generally available at banks, building societies, the Post Office® and some supermarkets and retailers. Opening the account is pretty straightforward, like opening a regular savings account. You will need the usual proof of age, identity and residence and you will need to agree to the rules and regulations regarding your ISA allowance.

Whatever type of ISA you choose to open, make sure you check that the ISA manager is fully approved by HM Revenue & Customs. They will also need to be fully regulated by the Financial Services Authority (FSA).

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Can I withdraw Money from my ISA?

Yes; and you won't lose the tax benefits you have already built up on the money.

But there are some things to bear in mind: you may need to provide notice of your intention to withdraw money. You may also some interest if you withdraw 'early'. If you have an ISA life insurance policy, you may even be charged a penalty. If you have an Investment ISA you may not get all the money back which you placed in the account, especially in the early years of an investment.

Note: If you withdraw money from your ISA, any capital you put back in later the same tax year will be counted against your annual allowance.

For example, if you open a Cash ISA using £2,500 in May and a month later you withdraw £2,000 but decide later that year to put money into the account you will only be able to replace £1,100. In other words you may only put up to the maximum allowance (currently £3,600) including the original £2,500 you put in when you first opened the ISA.

--> £2,500 + £1,100 = £3,600

...the withdrawal you made in June is not included in the final sum as far as your maximum allowance goes.

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Can you Transfer an ISA?

This depends on your provider. They may accept transfers or not – make sure you find out in advance. If they do permit transfers, you have the option to transfer money from your Cash ISA to another Cash ISA or to an Investment ISA. Generally, it is the new ISA provider who arranges the transfer so you will need to request this.

You may not close an old ISA and start a new one – only transfers are possible. Note that you cannot transfer from an Investment ISA to a Cash ISA. Therefore, it is wise to consider your options ahead of any transferrals.

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Which one should I apply for: a Cash or Investment ISA?

The answer to this question is, of course, that it is entirely up to you and how you would like to invest your money.

A Cash ISA is more ideal for people who want a low-risk way of growing their money. After you have opened the account, you can just allow the money to sit and gather interest plus enjoy the tax benefits. Make sure that you shop around to see which provider offers the best rates and terms.

An Investment ISA is good for people who don"t mind a bit of risk to their capital – with the chance that it could grow more significantly than were it just to sit and gather interest. You can place more money into an Investment ISA as it has a higher allowance but you will need to get good advice and assistance in where to invest the money.

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What are the Benefits of ISAs?

There are some great benefits of investing in Cash or Investment ISAs – the key being the tax benefits.

  • Capital Gains Tax

If you make returns from any investments sold within your ISA, they will not be subject to Capital Gains Tax (CGT). However, if you make a loss, you may not offset these against gains made elsewhere.

  • Income Tax

For a Cash ISA, you will receive interest on the money without being charged income tax. Equity investments within an ISA are not subject to the extra 25% on dividends which apply to those in the higher taxpaying bracket.

Other benefits include the ease with which you can open and run an ISA account.

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What are the Disadvantages of ISAs?

With a Cash ISA, the main disadvantage is the limit – you may only place a limited amount in the account each tax year. Also, if you only place a small amount of money in a Cash ISA, it may not gather a significant amount of interest.

For an Investment ISA, you bear a disadvantage in that you are placing you capital at risk. In other words, you are placing capital in one or more investments or products (such as shares and bonds) which might lose value over the time that your money is invested in them.

Risk exposure is present in any form of investment. If you are unsure about how much money you should invest (or save) and which products are suitable for you, then seek independent financial advice.

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