Share ISAs

A share ISA enables you to invest your money into the stock market, rather than just saving it. You can either take out a mini share ISA, into which you can put up to £4,000 in a tax year, or you can incorporate your investments within a maxi ISA, and put in up to £7,000 in a tax year.

You can put your money into any fund run from the UK or any company listed on a 'recognised stock exchange'. A recognised stock exchange means most major markets, such the London or New York Stock Exchange.

AIM, the Alternative Investment Market, which is a market for small companies here in the UK is not a recognised stock exchange so, as a general rule, you can't put AIM shares into an ISA. The situation is complicated by the fact that a few AIM companies, mostly mining shares, can be put in an ISA because they also have a listing on another recognised stock exchange. If you're in any doubt as to whether you can put a share in an ISA it's best to speak to your broker first.

Shares ISAs & Tax

Once your investment is safely sheltered within a share ISA, it will be protected from both income tax and capital gains tax (CGT).

Income Tax

The income tax benefits from share ISAs are less pronounced than for cash ISAs and only higher rate taxpayers benefit.

Outside of an ISA you don't pay any tax on dividends if you are a standard-rate taxpayer so there's no income tax advantage in holding them within an ISA. However, higher rate taxpayers enjoy a tax benefit, as they don't have to pay any additional tax on their dividends, as they would do if the shares were held outside of an ISA. For example, if a higher-rate taxpayer was to receive £100 of dividends on investments held outside of an ISA, they would have to pay additional tax of £25.

One further issue to think about is that if you are a basic rate taxpayer now but suspect you might be a higher rate taxpayer in subsequent years. Using an ISA in this instance could save income tax in future, even though you won't get any immediate benefit.

Capital Gains Tax

The main tax benefit that share ISAs offer is protection from Capital Gains Tax (CGT).

If you make a small one-off investment in an ISA then it is unlikely that you will ever save much in the way of CGT as you are allowed to make a certain amount of capital gains each year before you have to pay anything (the limit is £8,500 for 2005/06). However, if you intend to use most of your ISA allowance year after year, and your investments do well enough, you could avoid a substantial CGT bill.

In the case of funds there are often no additional charges to pay by sheltering your investments within an ISA, so you are often getting your tax protection at no additional cost. If you are investing in individual shares you may have some additional charges to pay for using an ISA. However, these are often capped and if you can bundle together several years' worth of ISAs together in one account you can usually limit these costs to around £50 per annum.

Note that there is one tax you can't escape, even within an ISA. This is stamp duty which is payable on all share or fund purchases. It is charged at 0.5%. There is no stamp duty to pay when you sell.

Types of Share ISA

Financial institutions offer different types of shares ISAs so you need to decide whether you want to be a hands-on investor or not before you open a share ISA. For example, some will let you buy a simple index-tracking ISA that follows the fortunes of a particular index. These are often the cheapest and easiest types of ISA to invest in.

Alternatively, you can leave everything up to the fund manager you've chosen and hope he or she does better than you could. In this instance, you'll be charged a fair bit more for their services than you would pay for an index tracker.

You can even choose your own individual shares if you opt for what is known as a Self-Select ISA. This is essentially a sharedealing account that sits inside an ISA. You can buy and sell shares, or even funds and other investments, within your ISA as often as you like.