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 actually an investment itself, but more of a protective wrapper into which you can put your money.
As long as your money remains in the ISA, then you do not have to pay any tax on it. Once you withdraw it, or if you close the account entirely, then it becomes taxable again. In other words, you want to keep your money inside the shark cage for as long as possible!
This last point is particularly important if you want to move your ISA from one provider to another (to get a higher rate of interest perhaps). Do not close your original ISA account because, if you do, your money will lose its tax protection. Instead you need to transfer your ISA from one provider to the other. The provider to which you want to transfer will be able to provide information about how to do this.
There are set limits as to how much money you can put into an ISA — more on these in a minute. These limits apply to each tax year, which runs from 6 April to 5 April the following year.
A little history
ISAs were introduced in 1999, replacing a similar scheme called PEPs that ran from 1987 to 1999.
The rules for ISAs have been changed a number of times since they were first introduced. Some of the changes have made them a little simpler to understand (hurrah!) while others had added a little complication (boo!). And since governments love to tinker with such things, there’s no doubt we’ll see more rule changes in future.
A major change took effect from July 2014, with substantially higher contribution limits for what were called New ISAs or NISAs. In practice, all ISAs, whether existing ones opened many years ago or those just started, have the same rules and are treated the same. The term NISA was just a useful distinction in the short time period before the changes in July 2014 were enacted.
Stocks & Shares ISA
They are two main types of ISA. The first is a Stocks & Shares ISA.
Everyone aged 18 and above can put up to £15,000 into a Stocks & Shares ISA for the 2014/15 tax year.
Find out how you can get a Stocks & Shares ISA using the Motley Fool Share Dealing Service.
The second type of ISA is a cash ISA. Unlike Stocks & Shares ISAs, the minimum age limit for cash ISAs is 16.
You can put up to £15,000 into a cash ISA for the 2014/15 tax year.
A bit of each?
If you like, you can open both a cash ISA and a Stocks & Shares ISA in the same tax year. However, the total amount you put in cannot exceed £15,000.
So you could invest £7,500 into each, or you could invest £5,000 in a cash ISA and £10,000 in a Stocks & Shares ISA. You can even have the whole £15,000 in a cash ISA if you like.
You can have both types of ISAs with the same provider, or you can have them with two separate companies. Most ISA providers will also let you combine cash ISAs from previous years into one big cash ISA. The same applies to Stocks & Shares ISAs.
One of the new rules added in recent years is that you can decide to convert a cash ISA into a Stocks & Shares ISA. As of July 2014, you can also do the opposite, i.e. go from Stocks & Shares into Cash.
How the contribution limits work
One thing that can cause a little confusion is how the contribution limits work.
The limits apply to all the money you put in during a tax year. So, for example, you can’t put your full allowance into a Stocks & Shares ISA in May, withdraw £2,000 in August and then put it back again in October. In this instance, you used up all of your ISA limit with your initial contribution in May.
Generally speaking, you can only put money into an ISA if you’re a UK resident. So if you go abroad, you can’t put any more money into an ISA. You can keep any existing ISAs that you have though.
What happens if you die?
As a final note, in more ways than one, once you pop your clogs that’s the end of your ISA as well. Any savings or investments you had in them become taxable from the date of your death and they are included in your estate for inheritance tax purposes.