ISA's were introduced in April 1999 to replace Tessa's and Pep's.
An ISA is a vehicle for investing cash and or stocks and shares that is free from income tax on cash balances and capital gains made on stocks and shares, providing the investment is in place for the tax year.
There are no statutory lock in periods but some providers will have terms and conditions that require the investment to be held for a certain period of time to gain higher rates.
Cash ISA's are available to an individual aged 16 and over, and Stocks and Shares ISA's are available at the age of 18 years.
The limit was for tax free savings and investments was raised in the 2009 budget from £7,200 to £10,200 for the tax year. Anyone aged 50 and over can take advantage of the increase in the 2009/10 tax year, those under 50 will qualify from 6th April 2010.
A 40% tax payer can save £4,080 each year and a 20% tax payer, £2,040 on the increased rates.
There are two types of ISA:
CASH ISA's
A cash ISA is purely a cash savings account.
An individual can invest half of the limit; £3,600 for under 50 years age and £5,100 over 50 in the tax year ending 5th April 2010.
Cash ISA's vary from fixed interest rates, easy access accounts, and notice period accounts. Interest rates can vary from each provider, so shopping around is advisable. Some ISA's may pay a higher interest rate for the first year then drop to a lower rate for subsequent years.
Generally, a fixed rate ISA will only allow lump sum payments into it, and will not allow cash withdrawals. Other types of account will allow payments at any time and will allow withdrawals subject to the terms and conditions of the ISA. Where withdrawals are made, the tax saving on that amount will be lost.
A cash ISA is the safest type, as the value of the cash remains the same, therefore you cannot suffer losses.
Stocks and Shares ISA's
A Stocks and Shares ISA can hold many different investments. Investments up to the entire limit can be made; alternatively you can have both a cash ISA and a Stocks and Shares ISA and invest up to 50% of the limit in each account.
Many accounts allow a savings plan whereby monthly payments can be made rather than lump sum investments.
This ISA holds more risk than a Cash ISA as stocks and share prices are frequently rising, and falling in some cases. However, the returns can be greater than those of the Cash ISA.
Transferring an ISA
There are many ISA products on the market; some of which pay higher rates in the first year.
If you find a better product and wish to transfer the funds; Cash ISA's must be treated by the original provider as a transfer, not an account closure as the tax advantage would be lost. Not all Cash ISA's accept transfers.
A stocks and Shares ISA can be transferred with no tax advantage loss.