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Individual Savings Accounts (ISAs) offer investors a tax-free way to grow their money over the long-term. Investors choose cash ISAs – akin to savings accounts – or stocks and shares ISAs. Money can also be split between both options.
Cash ISAs are fundamentally like regular savings accounts, but the interest investors earn is tax-free. Currently, people under age 50 can save £3,600 per annum, but starting in 2010 everyone will be allowed £5,100 per annum. Most cash ISAs allow investors to instantly access their money and most provide a solid rate of return. There are those whose interest rates are low enough to make them unwise, however, so investors need to research the options.
Share ISAs are tax-free accounts that hold shares, funds, and other stock-market-type investments. Investors are allowed to hold bonds and gilts and any interest earned is also tax-free. The ideal is to choose bonds issued by sound organisations that provide a decent rate of return and that have low fees. For the current year, those aged 18 years and older can invest up to £7,200, £3,600 of which may be invested in a cash ISA. Investors can also choose to invest the full £7,200 in a share ISA. Starting in April 2010, everyone will be able to invest up to £10,200 per annum, of which £5,100 may be placed in cash ISAs.
Given that everyone has a capital gains tax allowance, share ISAs may not be necessary if investors only want tax-free savings. The current allowance for capital gains is £10,200 per annum. That means investors can make a profit of up to this individual capital gains limit and not have to pay any tax on it.
Switching Between Cash and Share ISAs
Investors can transfer money from a cash ISA to a share ISA. The reverse is not true; investors are not allowed to transfer a share ISA to cash. This can prove problematic if the market is in freefall. In such a case, investors can open a self-select shares ISA and hold cash there, so long as the intention is to invest eventually. Investors will have to pay a tax of 20% on any interest earned. It's also difficult to find self-select ISAs that pay a decent return. It may be worthwhile, however, if investors need to shield their money in the short-term.
ISAs offer attractive saving options, but investors must do their research. If it seems too complex, independent financial advisers can help choose proper investments.