What is an ISA?

ISA stands for Individual Savings Account which since 6 April 1999 have replaced PEPs (Personal Equity Plans) and Tessas (Tax Exempt Special Savings Accounts).

Existing PEPs are unaffected and you can continue to hold them for as long as you wish but you cannot make any fresh contributions to them. Tessas can also continue and you can continue to make payments into them subject to the maximum yearly limits for the scheme. When your Tessa matures after five years, you can transfer the amount subscribed (but not the accumulated interest) into an ISA. Some banks and building societies offer special Tessa Only ISAs for this purpose.

We categorise ISAs according to the different types of underlying investment available as follows:

Investment Trust Maxi ISA
Unit Trust or OEIC Maxi ISA
Stock Maxi ISA
Self-Select Maxi ISA
Bank or Building Society Mini ISA

There are few restrictions in the types of shares you can invest in through ISAs. For instance you can invest just as much in US shares as in the UK and the EU. It will probably be advisable to invest through Investment Trust Shares, or Unit Trust or OEIC Index Tracker but you will usually also be able to invest in Gilt Index-Linked, Gilt Fixed Interest (provided ths stocks have more than 5 years to run when bought for your ISA) or Loan and Debenture either in a fund or an individual bond or stock (provided the bond or stock has more than 5 years to run when bought for your ISA) .

Up to £7,000 can be invested each year per person in an ISA of which £3,000 can be kept as a tax free cash deposit. The proposal to reduce these limits has been withdrawn and they will now continue to at least 2010. Where you just decide to invest in the cash deposit, we call it a Bank or Building Society Mini ISA . Cash unit trusts are not be eligible for the stocks and shares component. You can temporarily keep money in the shares and stock component in cash, in which case 20% tax is payable on the interest.

Since tax changes to the treatment of dividend income which have been phased in, the only tax advantage of an ISA is that gains are exempt from capital gains tax. For basic tax payers invested in UK shares, the tax on the dividend is the same although higher rate taxpayers pay slightly less.