There are two types of ISA (individual savings account): cash ISAs and stocks and shares ISAs. The advantage of having an ISA is that it is tax-efficient. Savings and investments held outside an ISA wrapper are liable to income or capital gains tax. You can invest in a single fund, more than one or pick the individual shares yourself.
ISAs can be used to:
- save cash - the interest will be tax-free
- invest in shares or funds - any capital growth will be tax-free and there is no further tax to pay on any dividends you receive
If you have money saved from a previous tax year you can transfer some or all of the money from a cash ISA to a stocks and shares ISA without this affecting your annual ISA investment allowance.
Money saved in the current tax year:
- savers are able to transfer money saved in the current tax year from a cash ISA to a stocks and shares ISA, but they must transfer the whole amount saved in that tax year in that cash ISA up to the day of the transfer
- the money transferred is then treated as if it had been invested directly into the stocks and shares ISA in that tax year; the saver is then still able to save or invest the remainder of their £11,280 annual ISA investment limit in the tax year 2012-13, including up to £5,640 in a cash ISA
How much tax will be saved?
Interest from savings:
- if you pay tax at the basic rate, outside an ISA you would usually pay 20 per cent tax (2012-13) on your savings interest
- if you pay tax at the higher rate, outside an ISA you would usually pay tax at 40 per cent on your savings interest
- if you pay tax at the additional rate, outside an ISA you would usually pay tax at 50 per cent on your savings interest
- if you pay the 'saving rate' of tax for savings, outside an ISA you would pay tax at 10 per cent on your savings interest
- if you're a basic rate taxpayer inside or outside an ISA you pay tax at 10 per cent on dividend income; this is taken as a 'tax credit' before you receive the dividend and cannot be refunded for ISA investments
- if you're a higher or additional rate taxpayer you would normally pay tax on dividend income at 32.5 per cent or 42.5 per cent; in an ISA you won't get back the 10 per cent dividend tax credit element of this, but you will save by not having to pay any further tax
If you make gains of more than £10,600 from the sale of shares and certain other assets in the tax year 2011-12 you would normally have to pay Capital Gains Tax. However, you do not have to pay any Capital Gains Tax on gains from an ISA. (But losses on ISA investments can't be used to reduce Capital Gains Tax on gains from investments outside the ISA.)