Investing - Choosing Individual Savings Accounts

ISAs replaced PEPs and TESSAs for new investments after April 1999 and are guaranteed to run for ten years. The annual limit for investment is £7,000 (£5,000 from April 2006). Income and capital gains in an ISA are tax free and dividends receive a 10% tax credit until 2004.


Investments can be in three components:


  • up to £3,000 (£1,000 from April 2006) in a cash component in banks, building societies, National Savings products (the taxable ones of course);
  • up to £1,000 in an insurance component single premium life assurance policies such as with profits bonds;
  • up to the full £7,000 (£5,000) in stocks and shares investment or unit trusts, preference shares, bonds and gilts or directly in equities (a self select ISA). There are no geographical limits as there were for PEPs.


There is a question mark over the value of the insurance component because insurance linked products pay income tax (albeit at a favourable rate), which cannot be recovered and no more tax is payable on investments outside an ISA except for higher rate taxpayers.


Shares arising from employee share option schemes can be transferred to a stocks and shares ISA without counting against the annual limit.


Although 18 is the starting age for ISAs, 16 and 17 year olds can invest up to £3,000 (£1,000 from 2006) in a cash ISA.


There are three kinds of ISA:


  • Maxi ISAs - up to the full £7,000 (£5,000) is invested with one provider, although it can still be broken down into two or three components.
  • Mini ISAs - you can have one, two or three providers, one for cash, one for insurance and one for stocks and shares (but you cannot forgo either the cash or insurance mini ISA to put £4,000 in stocks and shares).
  • TESSA only ISAs when a TESSA expires, the capital element (but not the interest) can be re invested in a cash or TESSA only ISA without counting towards the annual ISA limit.


You cannot invest in both a maxi ISA and a mini ISA in the same year.


Income can be left in or withdrawn but once taken out neither income or capital can be put back into that year's ISA.


CAT standards exist for ISAs (charges, access, terms) to protect inexperienced investors but providers do not have to follow them.


Are they good value?


There has been some debate about the value of PEPs, particularly for standard rate taxpayers, since not many People pay capital gains tax and the extra charges could be greater than the income tax savings. However, this dates back to the time when PEPs could only be invested in equities. The same questions arise in connection with ISAs.


Statistics of returns over a period are only available for the time when PEPs were limited to equities. They show that equity investment through a PEP achieved a higher return although it took a lengthy period for the difference to be significant.


Corporate bond ISAs and PEPs


Now that ISAs and PEPs can be invested in company fixed interest stocks and shares, producing more income than equities at least to start with (as well as incurring less risk), there will be a tendency, particularly in the case of higher rate taxpayers, to use ISAs and PEPs in this way.


Another reason is that the full amount of tax deducted at source from company fixed interest stocks can be recovered by the ISA manager instead of the limited recovery of tax deducted from dividends.


Choosing an ISA


Even when you have decided on the type of ISA you wish to invest in, there is still a wide choice. Here are some questions to ask the ISA provider:


  • What are the initial/exit and annual charges and are they charged to income or capital?
  • What are the dealing costs (if applicable)?
  • What is the charge for transfer to another provider?
  • Is there any charge for switching between the provider's own funds?
  • Are there charges for collecting dividends, getting company reports and attending AGMs?


It is possible to have a self select share ISA in which you choose which shares or units to invest in and you can trade in the usual way (this also applies to PEPs). There is no specified limit as to how long you can hold cash - the criterion is an intention to invest.


Putting all your annual share ISA money into one unit or investment trust, while economical, can be somewhat risky, especially in the case of an ISA mortgage, but you can spread the risk by choosing a different investment sector for each ISA year.


Fund supermarkets are worth considering for ISAs.


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