ISA explained - Maxi and Mini ISAs, benefits of an ISA and ISA Transfers

Individual Savings Accounts (ISAs) were introduced in 1999 to replace Personal Equity Plans (PEPs). When you invest through an ISA, the income and growth are free of income and capital gains tax and you do not have to declare an ISA on your tax return.

An ISA is not itself an investment, but is effectively a "wrapper" within which an underlying investment is held.

ISAs can include one or two components:

Cash (bank and building society savings accounts, National Savings)

Stocks and shares, (unit trusts, shares, bonds, etc)

Until 5 April 2010 you can pay an overall total of £7000 into ISAs each tax year.

Maxi and Mini ISAs

There are two types if ISA - Maxi and Mini. In each year you can either invest in one Maxi ISA, which can include a mixture of cash (up to £3000) and stocks and shares, or two Mini ISAs.

There are two types of Mini ISA - a cash ISA, and a stocks and shares ISA. You can open each ISA with a different ISA manager if you wish and you can invest up to £3000 in a cash ISA and up to £4000 in a stocks and shares ISA, but you cannot open more than one of each type in the same tax year. And you cannot invest in both a Mini ISA and a MAXI ISA in the same tax year.

What are the benefits of ISAs

There are several reasons to invest within an ISA:-

You pay no tax on any of the income you receive. This includes dividends, interest and bonuses.

You pay no tax on capital gains arising on your ISA investments.

ISAs do not have to be mentioned on your self-assessment tax return.

For those hovering on the threshold between one tax band and another, investing within an ISA could make the difference between falling into the higher rate band or not as income from an ISA is not included by the Inland Revenue in tax band calculations.

For those over 65, income received from investments held within an ISA does not erode the higher personal tax allowance they receive.

For higher rate tax payers, dividends received from investments held within an ISA are not liable to the additional 25% tax levied on the net amount of dividends received from other investments.

What about PEPs and PEP/ISA transfers?

PEPs, like ISAs, can be used as a "wrapper" for a range of investments, and now have the same tax benefits as ISAs. You can no longer take out a new PEP which also means you can't subscribe new money to existing PEPs. However, if you already have a PEP you can transfer the investment to another PEP provider, or switch investments within the wrapper.

If you have accumulated a number of PEPS and ISAs investments over the years, it is important to review their performance regularly as:

Your investment needs may have changed.

The funds that you may have invested in may not have performed well.

Prior to 6 April 2004 dividends paid on UK company shares held within an ISA received a tax credit of 10% - which was passed on to the investor by the plan manager. So, for every £90 dividend the investor actually received £100. The repayable dividend tax credit was abolished in April 2004.

New rules to simplify ISAs will come into force in April 2008

The reforms will remove the distinction between maxi and mini ISAs and allow transfers from a previous year's cash ISA into a stocks and shares version.

Investors who still hold PEPs will be able to transfer their money into an ISA wrapper, and children with child trusts will be able to roll over their investments into an ISA on their 18th birthday.

As well as simplifying the rules, the reforms will also make ISAs a permanent fixture of the savings landscape, with the government pledging that the maximum annual investment will always be at least £7,000.

Tony Ahearne, Director, Moneyspider Limited
Tony has been an Independent Financial Advisor for over 30 years.

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