The ISA (Individual Savings Account) was introduced by the government in 1999 to encourage saving among the UK population. The major incentive of an ISA is that the returns investors make on investment are tax efficient. Money invested in ISA accounts are sheltered from income and capital gains tax.
Cash ISAs: A safe bet
There are two types of ISA; Cash ISAs and stocks and shares ISAs. Cash ISAs function in a very similar way to conventional savings accounts, but they have a major advantage because the returns are tax-efficient.
The concept of the Cash ISA is very simple; you pay in your Cash according to the ISA allowance, which is the set limit for the tax year, and your money earns interest that is not taxable. There are different types of Cash ISAs available and they work in slightly different ways; you may have to invest a minimum amount with some providers and you can also choose from fixed-rate accounts.
Cash ISAs are not designed to make you millions; however, they are a wise investment and an essential product for people who are looking to safeguard their initial investment and gradually earn interest on their money. The amount you make will depend on the sum you invest and the interest rate. As there is a set limit, it is not possible to make a large amount of money using Cash ISAs. The interest you do earn will be tax efficient, so it is well worth considering a Cash ISA over a traditional savings account.
Stocks and shares ISAs: A risky business?
As with Cash ISAs, there is an allowance for stocks and shares ISAs; however, the limit is higher and thus the opportunity to potentially realise superior returns is enhanced.
The money you make on shares held within your ISA will not be taxed. Savvy investors look to create a diversified portfolio of investment funds within their stocks and shares ISA . By their nature, the stocks and shares ISAs are more risky than Cash ISAs, but the potential returns are healthier. Please remember, the value of investments can go down as well as up and you may get back less than you invested.
Looking to the future
If you are looking to save money and invest in your future, it may also be worthwhile considering a SIPP (self-invested personal pension).
The money you invest in your SIPP is free of basic rate tax, higher rate tax payers can reclaim the additional benefit through their tax return. On retirement (minimum age 55), you can make up to 25% of the total pension value as a tax-free lump sum. The plan allows you to choose from a range of funds and the returns will be protected and available to use when you retire.
ISAs were not set up as a means of making people millionaires overnight, but if you choose to use your ISA allowance 2012 to invest in stocks and shares and are open to accepting some risk, your decision may pay off.
ISAs offer the saver added incentives to normal savings accounts because although you pay tax on the money you put in, you do not pay tax on what you take out, so you can maximise your savings and make your money go further.
Cash ISAs are a great way to gradually build on your investment, but if you want the opportunity to make a large sum of money, you can consider opening a stocks and shares account; choose wisely and you could reap the rewards. The eligibility to invest in an ISA or SIPP will depend on your individual circumstances, and all tax rules may change in the future.