ISA masterclass #1: What's an ISA?

ISAsWhat are ISAs, and how much can you put into them?

What actually is an individual savings account, or ISA? With the way they're advertised, you could be forgiven for thinking an ISA is an investment product in itself -- such as a fund of some sort.
But an ISA is just a tax-free wrapper that can be used to protect a number of different types of investments. Once an eligible investment is ISA-wrapped, you don't pay tax on any gains you make.

The ISA we see advertised the most is the cash ISA -- and the banks advertising them do try to make them sound fancy and sophisticated, don't you think?

"What's the difference between a cash ISA and a savings account?" you may ask. Nothing much, because a cash ISA actually is a savings account, albeit one on which interest is paid gross, with no tax on interest applied.

ISA allowances
Of course, no government is going to let us have too much of a good thing, so the amount we can put into an ISA each year is limited.

For this financial year, which ends on 5th April 2012, the total ISA limit is £10,680 per person. Of that, a maximum of £5,340 can be invested in a cash ISA, with up to the full £10,680 allowed within a stocks and shares ISA. The £10,680 limit is a pretty sizeable sum to most people, especially when we consider that a couple can invest £21,360 a year between them, tax-free.

Once invested, as long as you keep the money within the ISA shelter, you'll pay no tax on this year's investments in any future years. It doesn't matter how well (or badly!) your ISA investments perform -- you'll still be able to top up your contributions with next year's full allowance.

And there's additional good news in that the ISA limits are tied to Retail Price Inflation, so from 6th April 2012 the annual contribution limit is increased -- to £5,640 for cash ISAs and £11,280 for stocks and shares ISAs.

You can take money out of your ISA any time you please, so it's not locked up for any length of time -- but be aware that withdrawals are ignored when it comes to contribution limits. So if you put £10,000 into this year's ISA and then withdraw £5,000, the current limit of £10,680 means you can only contribute a further £680 during the present tax year.

What's next?
If you have any questions on what we've covered today, just ask in the Comments section below and we'll do what we can to help. In the next article, we'll examine what you can put into an ISA.

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