What is an ISA?

What You Need to Know

ISA's allow you to earn interest on your savings, tax free.
There are two main types of ISA, cash and shares based.
In both cases you can only pay in a limited amount each year, though the limit is higher for shares based ISAs.
The limit on how much you can deposit in an ISA does not take any withdrawals you might make into account, so it can be best no to move money in and out too frequently.
Once you have an ISA, you do not have to stay with the same provider. If you're unhappy you can switch for a better interest rate.
Historically shares based ISAs have out performed their cash equivalents.

Individual Savings Accounts (ISAs) are essentially a tax-free way of saving money. Your account works in the same way as a normal savings account, except that you won’t have to pay tax on the interest you earn.

There are two types of ISAs; cash ISAs and stocks and shares ISAs. This article will help you to decide if a cash ISA is the right way for you to save.

How much can I save in a cash ISA?

Because the interest you earn on your savings is tax-free in an ISA, the government has set limits on how much money you can invest in each tax year.

For the tax year 2013/14, this is set at £5,760. This means that between 6 April 2013 and 5 April 2014 you can save up to £5,760 in a cash ISA, whether in small deposits over the year or as a single lump sum.

The amount you can invest into a stocks and shares ISA is higher, but these are a little more complicated.

What happens if I take money out of my ISA?

The annual limit on your cash ISA refers to how much you can pay in rather than the actual balance of the account. This means that although you can take money out of your account and put cash back in, you can only deposit a maximum of £5,760 in any tax year.

For example, if you paid £1,760 into your cash ISA in April 2013, then took it out in May, you would still only be able to pay in a further £4,000 until the end of the tax year.

If you paid in your full ISA allowance in April 2013, then took £1,000 out the next month, you would still have used up your year’s allowance – and would have to wait for the new tax year before you could pay any more money into your account.

The new tax year

Each year on 6 April, your tax-free ISA allowance starts all over again – regardless of how much money you’ve got in your account.

So if you already have paid in your ISA allowance from the last tax year, you would be able save another £5,760 when the new tax year starts.

Again, it’s important to stress the fact that your annual limit refers to the amount of money you can pay in to your account over the course of a year, not the amount you can keep in the account altogether. You should also note than once the tax year ends, unused allowance can't be carried over.

Shares Based ISAs

A shares based ISA is one in which your money is invested rather than saved, usually in a pooled fund. Your returns will be protected from capital gains tax and higher rate tax payer's will also get relief from dividend income from share's based ISAs.

Shares based have a higher pay in limit than cash options. You can invest up to £11,520 during the 2013/2014 tax year. If you also have a cash ISA, you should bear in mind that this limit applies to both your ISAs combined. So, if you used all your cash allowance (£5,760), you could also only put £5,760 into a shares based ISA.

Can I switch my cash ISA?

Yes. Many people stick with poor interest rates because they think that switching is too complicated. But switching your ISA can get you a much better return on your savings.

The main thing to remember is that you should arrange the switch with your new ISA provider, who will be able to transfer your savings for you. Don’t simply take the money out to move it yourself – you’ll lose your tax relief if you do this.

How much tax will I save?

The amount of tax you would normally pay on your savings interest depends on how much income tax you pay, explains the government website Directgov.

If you pay tax at the basic rate, you would usually pay 20% on your savings interest
If you pay tax at the higher rate, you would usually pay 40% on your savings interest
If you pay the “saving rate” of tax for savings, you would usually pay 10% on your savings interest.

So by keeping your savings in a cash ISA, you could save 10%, 20% or even 40% on the interest you earn.

Compare ISAs

Savings accounts aren’t all about how much you can earn – you need to think about what kind of saver you are as well. Think about whether you want instant access or an annual interest payment – which could get you a higher rate. You might want to manage your account online or have an ISA at a local bank. These extra benefits are important as often interest rates are fairly uniform across the various UK high street banks.

Cmparing ISAs deals online allows you to look at all the options and find the best possible return on your cash.