Individual Savings Accounts (or ISA) are a great financial planning tool. The UK government introduced ISAs in 1999 to encourage UK residents to save for the future. Although the name implies a savings account, ISA is not a regular savings account. ISA offers a tax-free way to save and invest. You’re entitled to keep the money earned from your ISAs, without paying tax on interest, dividends, bonuses and capital gains.
There are two types of ISAs: cash ISA and investment ISA (stocks and shares). In the tax 2013/14 year that runs from 6 April 2013 to 5 April 2014, you can invest up to £11,520 in ISAs. You can choose to invest the full amount in an investment ISA or save up to £5,640 in cash ISA, with the remaining balance of £5,640 in an investment ISA.
With cash ISA rates low, is it better to switch to an investment ISA? Here are some important things to consider when comparing the two:
Length of investment
A cash ISA is more suitable for short-term savings and it’s a better choice if you prefer liquidity. In contrast, investment ISA is ideal choice for long-term investment if you can afford to set aside your money for at least 5 years or longer. However, the value of your investment may go down and there is no guarantee that you’ll make a profit.
Your cash ISA can include cash deposited in banking and building society accounts as well as life insurance policies, shares in companies, and stakeholder medium-term products that fail to meet the qualifying conditions for investment ISAs. On the other hand, with investment ISAs, you can buy into individual shares, corporate bonds, equities, unit trusts, investment trusts, open-ended investment companies (OEICs), exchange-traded funds (ETFs) and gilts. With so many investment products to choose from, you should keep your portfolio simple and diversified to mitigate risks.
Where to open an ISA
You can open a cash ISA account with an ISA manager such as a bank, building society, and National Savings and Investments. Select ISA managers who are approved by HM Revenue & Customs (HMRC) and authorized by the UK Financial Services Authority (FSA). For an investment ISA, you need to be invested on an investment platform such as Interactive Investor, in order to access the wide range of investment products. The investment platform allows you to hold your investments in one place, monitor your portfolio performance and rearrange your investments. Most investment platforms also offer trading tools such as market news, company news and reports, and learning guides. Some investment platforms may offer ‘self-select’ ISAs that enable you to choose a variety of shares and securities to build your portfolio.
Different platforms offer different range of investment choices and charge differently. Make sure you find out from your ISA manager about the charges of managing your ISA and whether there are penalties for early withdrawal and switching from one ISA manager to another.
While you need to be at least 18 years or over to open an investment ISA, you can open an adult cash ISA on your 16th birthday. Many investments that qualify within an ISA carry certain other restrictions. For instance, you can only invest in foreign shares that are listed on a recognised stock exchange. You need to weigh up the pros and cons of buying individual foreign shares in your portfolio.
For tax purposes, people who qualified for an ISA include residents in the UK, a Crown employee such as a diplomat or a member of the armed forces who is working overseas and paid by the UK government. An ISA cannot be hold jointly with, or on behalf of, another person.
In each tax year, you can only subscribe to one cash ISA and one investment ISA. However, you can choose different managers in different years. Hence, there is no limit on the number of different ISAs you can hold over time.
Whichever type of ISA you choose, it is important to have a good knowledge of the investments you want to hold and design your investment strategies that reflect your desires, goals, and risk threshold. If you’ve not used an ISA before, a lower-risk cash savings option may be a good start, before moving onto investment ISAs.
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