Individual Savings
Accounts

What is an ISA?

ISA stands for Individual Savings Account. An ISA allows UK residents to invest an allowance each year – currently £10,680 in total, and £5,340 in cash – into a savings account that is exempt from tax. Once this has been invested into an ISA, it can remain tax-free as long as it remains there.

How Savings Are Taxed:

The interest on savings is classed as income and is subject to tax once all personal allowances have been accounted for.

The starting tax rate for savings is 10% for savings income up to £2,560. If non-savings income is above this amount, the 10% starting rate does not apply.

Any interest earned on savings which, included with other income, falls between £2,560 and £35,000, is taxed at the basic rate of 20%. When income falls between £35,000 and £150,000, interest is taxed at 40%. When income exceeds £150,000, interest is taxed at 50%.

Savers on low income may be able to claim exemption from tax on savings by completing an R85 form at their bank. With the lower bracket, however, the only relief that savers will find from tax on savings income is through an ISA that provides tax free returns.

Types of ISA / How to Invest:

There are two types of ISAs: cash ISAs, and stocks / growth / investment ISAs. Savers are able to invest into one cash ISA and one investment ISA in a single tax year. The yearly ISA allowance can be allocated as follows:

• Savers can invest the whole amount (£10,680) into an investment ISA;
• Savers can invest a maximum of £5,340 into a cash ISA;
• Savers can spread their investment across both types of ISA, adhering to the maximum cash ISA allowance.

If savers invest less than the maximum allowance into a cash ISA, the full yearly allocation can still be met through an investment ISA. UK savers must be aged 18 or over to qualify for an investment ISA.

Any portion of the yearly allowance that goes unused is lost and cannot be carried over. Money invested in an ISA, however, will remain tax-free as long as it remains within an ISA.

Savers are not restricted to any one ISA or any one provider. However, they can only invest in one cash and one cash ISA in any tax year. It is also possible to hold both a cash and an investment ISA with the same provider.

The maximum ISA allowance is irrespective of any withdrawals made throughout the tax year. Once the full £5,340 has been invested into a cash ISA, no further deposits can be made until the following tax year, even if withdrawals have been made.

Most banks and building societies offer a wide variety of cash ISAs. These operate in a similar manner to taxable savings accounts, with instant-access and fixed rate options available.

Stocks and shares ISAs (or growth ISAs) are more suitable for those looking to invest over longer periods. Growth ISAs tend to involve an element of risk, with variable returns dependent on the performance of stocks. However, with careful negotiation, stocks and shares ISAs could end up yielding more than cash ISAs.

Why Invest in an ISA?

ISAs are a great way to make your savings deliver more. The best feature of an ISA is that no tax is payable on any of the income received from savings and investments. This includes savings interest, dividends, and capital gains.

ISAs can also be an effective means to beat inflation. [See Which4U’s guide on How to Beat Inflation for more details.]

Transferring your ISA:

Both cash and investment ISAs can be transferred to other providers, though this must be done by requesting a transfer rather than by withdrawal. You are able to transfer some or all of the money saved in previous tax years without affecting your annual ISA investment allowance. You cannot, however, transfer a stocks and shares ISA into a cash ISA.

Check the terms and conditions with your ISA provider to find out if you will be charged for transferring.

What Protection is Provided for ISAs?

Cash ISAs are protected in the same way as normal savings accounts. In the event that the ISA provider collapsed, the Financial Services Compensation Scheme (FSCS) guarantees savings up to £85,000 per registered institution.

For more details about this scheme, including non-UK providers, see the 'compensation' section on our main savings account page and our guide on Secure Savings and Compensation.

Stocks and shares ISAs are defined as risk products, so a different level of FSCS protection applies:

Money is covered if the product provider of the investment collapses; for example, a bank providing an investment ISA. But losses on shares and redundant shares in a collapsing company are not protected as this is classed as the risk inherent in higher-yield investment products.

If shares have been bought through a stockbroker, they remain the property of the investor if the broker collapses.

What to Remember With ISAs:

All accumulated ISA savings from past years will still provide tax free interest. The amount that a well-built ISA could save in tax is substantial. [See our guide to Cash ISAs for more details.]

If unhappy with the rate of return on an ISA, it can be transferred to a new provider. The new provider must arrange the transfer. Closing ISAs or manually withdrawing money will disengage funds from their tax-free status.

ISA providers must be authorised by the Financial Services Authority and approved by HM Revenue & Customs. This provides access to complaints procedures, the Financial Ombudsman Scheme and the Financial Services Compensation Scheme if problems arise.

ISAs in 2012/2013:

From April 2012, the following changes will apply to the values listed above:

• The individual ISA allowance will rise to £11,260 (£5,640 in cash).
• The upper limit for the starting rate of savings tax will rise to £2,710.
• The upper income band for the basic rate of tax (20%) will fall to £37,370.