In the UK, an Individual Savings Account (ISA) might be one of the best financial vehicles offered to the average citizen. An ISA offers the opportunity for tax-free savings that are exempt from both income and capital gains tax. While there are limits as to the amount of money one can invest on an annual basis, there are no limits to withdrawals.
The UK ISA was established in 1999 as the successor to the Personal Equity Plan (PEP) and Tax Exempt Special Savings Accounts (TESSA). When first offered, they were hailed as a financial vehicle for the common person, rather than the previous plans that seemed to benefit only those with means. Today the ISA remains one of the UK's most well loved financial options.
Three Types of ISA's
There are three types of ISA's: the cash ISA, the stocks and shares ISA, and the junior ISA. Each one targets a specific type of investor and has its own stipulations.
The cash ISA is the most common option among adult investors. Its only source of funding, as the name implies, is cash. With the exception of its tax exempt status, a cash ISA is nearly identical to a standard savings account. An adult consumer can contribute as much as £5340 annually. That number is set to go up in 2014.
The stocks and shares ISA is also for adults. It is funded by a combination of cash and qualifying investments like stocks, corporate bonds, and government instruments. In order to qualify, the chosen investments must stand a reasonable chance of losing at least 5% of their value while being held. The annual limit through 2013 is £10,680.
The junior ISA was only instituted in late 2011. It is an ISA for investors under the age of 18 opened with the intent of teaching them financial management prior to adulthood. Like adult ISA's, they are available as both cash and stocks and shares accounts. A junior ISA automatically converts to its adult counterpart once the child turns 18.
Opening an ISA
Opening an ISA is not difficult although you cannot just walk into any store on the street and do so. According to information provided by HM Revenue & Customs, ISA's are only available through approved ISA managers. Approved organisations would include institutions like banks, insurance companies, investment companies, and friendly societies.
ISA managers will likely give you all of the information you need upon your initial inquiry. You can visit a local branch office, call them on the telephone, or look them up on the Internet. However, please note that it is up to the individual consumer to do the research before opening an ISA. Managers will not go out of their way to handhold consumers and make decisions for them.
If you need help understanding ISA's, the Financial Services Administration (FSA) has a fair amount of information on their website. You can also call the FSA Consumer Hotline to speak with someone in person. Alternatively, the local branch of your bank may have financial specialists able to advise you on proper ISA investing.
The tax-free nature of ISA's makes them great investment vehicles for a variety of purposes. For young people one of the more common strategies is to begin saving at the age of 16 in order to build a tax-free fund to purchase a home after marriage. These young people can take advantage of the maximum investment limit to put away a significant amount of money over a ten-year period. With some sound investment advice, it is even possible to use a stocks and shares ISA to fully fund a house purchase and avoid a mortgage altogether.
Parents are taking advantage of ISA's to fund their child's education or set money aside for their own retirement. As a retirement vehicle, an ISA is a great choice because withdrawals are tax-free. Again, investing up to the annual limit every year will add up to quite a sum of money over the long haul. It provides a great opportunity to pad your pension in order to ensure a comfortable lifestyle upon retirement.
ISA's can also be used for funding business start-ups, paying medical expenses, providing long-term care for older parents, funding annual holidays, and so on. No matter what you decide to use the money for, the ISA gives you the opportunity to save tax-free.
The Importance of Interest Rates
In their comprehensive guide to ISA investing, This Is Money recommends investors pay careful attention to interest rates. Different ISA managers offer varying rates depending on the type of ISA chosen and the length of investor commitment. A higher interest rate will bring a greater yield but it will also require greater commitment from the investor.
Interest rates are key to helping investors reach their long-term goals. That is why it is important to discuss your goals with your manager and plot out a strategy together. Of course, that means you will have to settle on an ISA manager prior to investing but do not worry, you are not going to be stuck with a fund manager whom you do not think is doing a proper job.
If you open an ISA with one manager, you are still free to transfer your account to another manager at a later date. However, there are stipulations to transfers, so make sure you know what they are before you initiate the action. There is plenty of information about transfers on the HM Revenue & Customs website.
The ISA is a great investment tool for UK residents of all income levels. It is one of the best things the UK government has done for its citizens in terms of promoting savings and teaching financial management. If you are the parent of young children, plan to help them invest in an ISA when they are old enough.
As for yourself, take advantage of tax-free investing and saving some money. An ISA, combined with a few other well thought out investments, could very well set you up for a very bright financial future.
Applying for an ISA online is easy and convenient. Here are some websites offering ISAs of varying terms and interest rates:
Lloyd's TSB - Apply for an ISA online with one of the UK's most respected names in banking. They offer two, three, and four year fixed-rate ISAs.
Scottish Widows - Since 1812, Scottish Widows has been helping UK residents plan their financial futures. Learn about their ISAs here and apply online.
Halifax - As a division of the Bank of Scotland Halifax is another option for ISAs. They have both fixed rate and variable options among the choices.
Aviva - Aviva is the sixth largest insurance company in the world and a UK fixture. Here ISAs can be set up as cash or stocks and shares products.
Axa - Axa Self Investor is a site where you can set up and manage your own ISA online. You get 24/7 account access, free switching, and full customer support.
Hargreaves Lansdown - A UK financial services and asset management specialist. At their site you can find plenty of information about ISAs; you can also open an account online and set up your ISA with them.
Alliance Trust Savings - Offers both cash and stocks and shares ISAs. They have won numerous awards including Best Stocks and Shares ISA Provider for 2011.
Self Trade - Self Trade is a self-directed investment site offering all sorts of investment products. You can invest in your own stocks and shares ISA by opening an account here.
Standard Life - At Standard Life, you can choose from among several different ISA options. For stocks and shares ISAs you can go with an easy investment strategy or choose from among their long list of funds.
Santander -As the third-largest UK bank in terms of deposits, Santander is a household name. There ISAs offer competitive rates and variable terms.
Marks & Spencer - Offers fixed and variable rate cash ISAs with the full protection of £85,000. Investors can apply online or by post.