ISA Basics

There's not much of our money that we can hide away from the prying eyes of the taxman but an ISA is one way of doing it.

ISA stands for Individual Savings Account and it's simply a special type of savings and investment account, which is more or less immune from tax. Think of an ISA as being like a shark cage, with your money floating around inside it completely protected from any encircling tax sharks. So an ISA isn't an actually investment itself, but more of a protective wrapper into which you can put savings or investments.

ISAs were introduced in 1999. They replaced a similar scheme called PEPs, which had been in existence for twelve years before then.

There are set limits relating to how much money you can put into an ISA in each tax year (a tax year runs from 6 April to 5 April the following year). Once each tax year is finished, you can no longer put any new money into your ISA for that tax year, but your money can remain invested, free from tax, for as long as you like (or until the government changes the rules relating to ISAs!).

They are two main types of ISA:

Mini ISA

You can put money into two mini ISAs each tax year. You can have a cash mini ISA and/or you can have a stocks & shares mini ISA. You can put up to £3,000 in your cash mini ISA and up to £4,000 into your stocks and shares mini ISA.

If you like, you can have a cash mini ISA with one company and a stocks & shares mini ISA with another. This is useful as investment companies, which traditionally offer stocks & shares ISAs, often don't offer great interest rates on cash ISAs. The best cash ISA rates are usually offered by banks and building societies.

Cash mini ISAs are by far and away the most popular form of ISA. Over 9.9m of us took one out in 2005/06, saving an average balance of around £2,200. By way of comparison, only 1.5m of us took out a stocks and shares mini ISA, investing an average of around £1,500.

Maxi ISA

You can only put money into one maxi ISA each year. You can invest up to £7,000 in each tax year, in a mixture of cash or stocks or shares. However, you can only put a maximum of £3,000 in cash into a maxi ISA whereas you can invest all £7,000 in stocks and shares if you like. In practice, most people who opt for maxi ISAs route seem predominantly interested in the stocks and shares component. In fact, stocks and shares account for around 98% of all the funds that go into maxi ISAs. In 2005/06, 1.5m people took out maxi ISAs, investing an average balance of around £4,500 each.

Which type should you go for?

The key thing is to decide is how much you're likely to invest in stocks and shares. If you want to invest more than £4,000 you'd be better off opting for a maxi ISA. If you're likely to invest less than this amount, go for minis ISA instead. This way, if you do want to use the cash element of your ISA, you'll still be free to hunt around for a separate cash ISA provider to get the best rate possible.

One final point to remember is that the annual subscription amounts referred to above are not affected by any withdrawals you make. For example, you can't put £3,000 into a cash ISA in May, take £2,000 of it out in June, and then put a further in £2,000 in July. Your £3,000 cash ISA limit was used by your initial contribution in May and, unfortunately, that's your lot until the next tax year comes around!