FOOL SCHOOL
ISA Basics

February 23, 2004

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 investment itself, but you put savings or investments in it.

There are three possible components to an ISA.

1. You can save cash inside an ISA and the interest will be tax-free;
2. You can invest in funds or shares in an ISA and any capital growth and dividend income will be tax-free;
3. You can invest in certain life insurance products in an ISA and the benefits accrued will be tax-free.

However, you'll not be surprised to hear that there are all sorts of rules and regulations governing eligibility, how much you can invest in each component and how many ISAs you can have. And just to complicate things even further, there are two types of ISA - the Mini and the Maxi - and you can only invest in one type in each tax year (which runs from April 6 to April 5 the following year).

ISAs were introduced in 1999. Before this time a similar system existed called PEPs. These were first introduced in 1987. Some people have invested in PEPs and ISAs every year and managed to build up a substantial sum, completely protected from tax.

Maxis and Minis

It's very important to understand the differences between Maxis and Minis because each year you are only allowed to invest in one of the two types. You already know that there are three components to the ISA - cash, shares and insurance. This is how you can use them in a Maxi:

The Maxi

Three components:

1. Cash
2. Shares
3. Insurance

Think of the Maxi like a big teapot with three different types of teabag in it. These are teabags of varying strengths and tastes that you can choose according to your fancy, more or less, but they all go into one single teapot. You will appreciate that if you put all three types into one teapot that you can only have one person be Mother. In other words, only one financial organisation can run your Maxi ISA for you.

The Mini

Three components:

1. Cash
2. Shares
3. Insurance

This time, think of three little teapots, each with its own teabag. This means, of course, that you can choose three different people to be Mother with whatever type of teabag you fancy. So, if one organization is offering great interest rates on their Cash Mini but you don't like the charges on their Shares Mini -- that's okay. Open their Cash Mini ISA and go to someone else for your Shares Mini ISA.

The important thing to remember - and it's so important we're going to repeat it - is that you are only allowed to take out one type of ISA each year. So if you open a Maxi this year then you're not allowed to have one of those cute little Minis as well. Or if you open just one of the cute little Minis you can't then decide you want a Maxi too. It's one or the other - until the next tax year when you're allowed to either continue with what you've already got, or start afresh.

It's entirely up to you whether you opt for the Maxi system or the Mini system. The Maxi is advisable for people who have larger sums to invest (over £3,000) and who have some knowledge of the stock market, as it allows them to put all their ISA allowance into investments each year - more on this later.

Minis are probably better if you are thinking of investing less than £3,000, as you are then free to go to other providers to ensure you can get a good rate on the cash component of your ISA.

Find out more in our ISA centre.