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By Lorrie Kelly Staff Writer
Friday, 11 April 2008
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WITH the start of a new tax year, now is the perfect time to consider your options and contribute to an investment account that not only keeps the taxman’s pocket lighter but also maximises the amount of interest you can earn.
And what better way to do that than through the only sure-fire tax-free savings account: an ISA.
What exactly is an ISA?
An ISA (individual savings account), is a tax free interest earning savings account that allows you to invest a maximum of £7200 per year.
This annual contribution can be comprised of up to £3600 in cash investment with the remaining £3600 being made in shares or stocks.
All investments must be made by the end of the tax year, April 5th, and if you do not use your maximum allowed contribution it will not roll over to the new tax year – it is lost forever.
How will I benefit from an ISA?
Simple. An ISA will increase the amount of interest you earn off your savings by 25% per year (for higher rate taxpayers, the saving could be as much as 66%!).
It does this by eliminating the tax that is normally incurred on ordinary savings accounts.
But I may need access to that money!
This is the most common misconception about ISAs, and it’s wrong!
Putting the maximum amount of money you can afford into an ISA doesn’t mean you can’t then touch it.
In fact, you can withdraw it as often as you like.
Withdrawals made from your ISA will not change its tax free status and for all intents and purposes, you can treat withdrawals from your ISA in exactly the same way as you do your current savings account.
But bear in mind that once you withdraw the money from your ISA, you can’t put it back in again until the new tax year.
And what happens at the start of next tax year?
The idea behind ISAs is to get Britain saving: You build the nest egg, and the government won’t tax the interest you make on it.
So at the beginning of the next tax year, you are allowed to put another £7200 to add to the total of your current ISA.
The year after that you can do the same again. And again, ad infinitum, slowly building up your tax-free nest egg.
By the way, you don’t necessarily have to invest it into the same ISA account with the same bank or issuer year after year (although you can’t split your ISA across issuers within the same year, eg. £1800 of your £3600 in one ISA account, and £1800 in another).
So there is only one kind of ISA, right?
No, there are actually two types of ISA but you’re not the only one to be confused.
Thankfully, old-school Mini and Maxi ISAs have been replaced as of the beginning of this tax year (which always begins on April 6th each year).
The often confusing system has been simplified into two, much simpler-to-understand, ISA types: - Cash ISAs, and
- Stocks and Shares ISAs
This simple distinction between the two types of ISA makes it much easier to understand where your money is being invested.
What is a Cash ISA?
A cash ISA works exactly like a normal saving account, except the interest you earn on the £3600 (or less) you put into it isn't taxed.
There are two kinds of Cash ISAs accounts: variable or fixed rate accounts.
The most common by far is the variable rate account, which means that the rate you sign up at may change as the interest rate changes (just like a regular savings account).
Don’t worry, if your current ISA is not offering the best return, you are allowed to transfer the entire sum to a higher yield account elsewhere (your ISA issuer will have the ability to perform this transfer).
But before doing so, it is a good idea to see if there are any penalty fees for transfer.
For those of us who like a more stable return on savings, you might consider a fixed rate account.
Fixed rate ISAs give you added security against any drops in the market yet still allow you to take advantage of higher interest rates offered by competitors through transfer.
The drawback is that you will not have regular access to your cash.
Most institutions require a 1-5 year commitment on the investment and charge anywhere from 60-180 days interest penalty for early withdrawals.
Either way, it is never a good idea to withdraw your ISA in order to move it elsewhere. This will result in losing your tax benefits for the year!
What is a Stocks and Shares ISA?
Stocks and Shares ISAs are a straight forward tax free investment in stocks and/or shares.
The maximum contribution allowed in this ISA is £7200 per year.
But using your maximum allowed ISA contribution exclusively on stocks and shares does mean you can’t put anything into a cash ISA.
If you need the flexibility to withdraw your savings throughout the year, it would be wiser to put at least some of your annual contribution into a Cash ISA, as you cannot freely withdraw your savings from a Stocks and Shares ISA.
Most experts agree that this is really a long term option suited to those who can afford to put their money away for at least five years.
And since the stock market can fluctuate, there is no guarantee of any growth on the money you invest (unlike the Cash ISA).
Of course, those willing to take the risk could always see far greater returns than what a Cash ISA could offer.
So what now?
With so much choice available in ISA accounts on the market, the recent regulation changes simplifying the process, and a long way to go until the end of the tax year there is bound to be one to suit your investment needs.
But do it now. Every day you delay you are giving away money to Alistair Darling!
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