An ISA is a financial tool that allows you to legally avoid tax that would usually be paid on your savings and investments. In effect, a proportion of your money can be placed within an ISA each year, allowing you to opt out of paying tax on that element of your finances.
As you accrue interest, or make gains from your investments, you’ll find that you can keep all of the profits. There’s no need to make any sort of declaration referring to this income.
If you’re thinking about getting an ISA, then it’s worth knowing that they are provided in a couple of different formats. There are clear limits on how much you are able to legally invest within an individual tax year and these limits are known as your allowances.
The first type is what is known as a cash ISA. This is a type of financial product that is available to all UK residents, as long as they are aged 16 and over. Your maximum individual allowance for the current tax year (up to 5 April 2013) is £5,640.
Although you are only able to invest into one cash ISA each year, it is possible to carry your previous savings over on an annual basis. What this means is that you’ll be able to keep adding to the ISA. As a result, it’s actually possible to build up a substantial level of investment over time.
You may prefer the idea of investing in a Stocks and Shares ISA, which is available to UK residents over the age of 18.
Investing money in a Stocks and Shares ISA means that you are effectively investing in the stock market. Any gains that you make as a result of this investment will not be liable for tax. Hence, this can represent a highly cost-effective approach to investing.
The total ISA allowance in 2012/2013 is £11,280 and though only half of this allowance can be invested in cash, you are able to invest that entire sum in a Stocks and Shares ISA. You’ll also find that there is plenty of flexibility within the system.
You might choose, as a result, to save some money into a cash ISA, with the remaining element of your allowance being invested in a Stocks and Shares ISA. You don’t have to use your full allowance.
It’s important to remember, however, that unused allowances do not roll over into the following tax year. In effect, they are lost for good.
Many cash ISAs, in particular, will allow you to get access to your money without the need to give much notice. This means that you can treat them in a similar way to a savings account, with the added benefit of tax-efficiency.
Despite the age limits that are in place getting an ISA, it is possible for parents or guardians to open a Junior ISA for children aged 17 or under. The current annual allowance for a Junior ISA is £3,600, although no money can be withdrawn until the child reaches the age of 18.
In order to ensure that you have the most tax-efficient approach to savings and investments, it makes sense to understand ISAs and the allowances that apply to you.
This is a guest post for Which4U provided in association with iCrossing Ltd.