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Everything you need to know about Isas

A beginner's guide to how to invest and save the tax-free way.

Q. What is an Isa and what can it invest in?

An Isa is a tax-efficient 'wrapper' in which savers can hold cash or investments. These accounts generally make a good starting point for setting money aside, because within an Isa any interest earned on savings is tax free, while on investments there is no further tax due on dividends paid out and no capital gains tax when they are sold.

There are two different types of account: a cash and a stocks and shares version. A cash Isa is basically a bank or building society savings account, with the difference that it enables you to earn interest tax-free. There are several types of cash Isas available from banks and building societies, including instant access, fixed-rate, and regular savings accounts.

The second type of Isa - stocks and shares - can hold a range of funds, individual shares, as well as government bonds and corporate bonds. As of 1 July they can also hold peer-to-peer loans, short-dated bonds and core capital deferred shares, used by building societies to bolster their capital base against potential losses.

This type of Isa carries more risk because your return isn't guaranteed and you may even lose money. However, the upside is that, historically, you are likely to achieve higher returns than cash over the long term.

Stocks and shares Isas provide greater income tax benefits for higher-rate taxpayers than for those paying basic-rate tax. That's because a 10 per cent tax is deducted from all dividend payouts at source and cannot be reclaimed within an Isa. Basic-rate taxpayers therefore pay the same 10 per cent rate on dividends whether the investment is within or outside an Isa; higher-rate taxpayers, in contrast, will pay a further 22.5 per cent tax on dividends from investments held outside an Isa.

Q. What are the annual limits?

As of 1 July 2014, you can set aside up to £15,000 for the 2014/15 tax year.

Where previously only half of your total Isa savings could be held in cash, you may now hold up to the £15,000 limit in either cash, or equity-based investments, or any mix of the two. The annual allowance must be used before 5 April each tax year, otherwise you will lose it.

Q. Who qualifies?

If you want to open a stocks and shares Isa you have to be aged 18 or over, whereas you can open a cash Isa when you turn 16. You also have to be resident in the UK for tax purposes, and you cannot hold an Isa jointly with, or on behalf of, anyone else.

Q. How much will an Isa cost me?

You don't have to pay anything to open a cash Isa - the only thing you need to consider is to find one with a competitive interest rate and suitable terms (for example regarding access to your money). Many cash Isas come with bonuses that expire after a year, so make sure to move your money.

The best way to buy investments in an Isa wrapper is through a fund supermarket or discount broker. Some will charge a set-up or annual fee. These offer a range of products with discounted initial and annual fund charges, making it much cheaper to invest. Some companies also reduce their rates in the run up to the end of the tax year. Websites such as www.candidmoney.com can point you in the right direction.

Q. What are the rules on Isa transfers?

The New Isa allows you to transfer freely between cash and stocks and shares. In practice, if you want to transfer from cash to stocks and shares, you will probably have to move your account to a separate equity-based provider (a fund platform, for instance), because few cash Isa providers have a linked broker.

It should be relatively straightforward if you want to move your money out of the stock market and into cash, or to hold cash for a while before moving it into the market. That's because most fund platforms and brokers have a cash 'park' already in place, for use as a short-term holding place for cash. Up to now, these cash parks paid minimal interest and that was taxed at basic rates, to ensure it remained a short-term option, but with the advent of New Isas the tax on interest paid on cash holdings will be scrapped.

However, it's expected that rates on cash offered by stocks and shares providers will remain less attractive than those from conventional cash Isa providers.

Q. Is there an Isa for kids?

Yes, there is. In November 2011, the government launched Junior Isas, or Jisas, to replace the child trust fund (CTF), which was abolished earlier that year. Like regular Isas, there are cash and investment Jisas to choose between. As of 1 July 2014 the annual allowance is £4,000. Children under the age of 18 are eligible to open one as long as they haven't already got a CTF.

If you open a Jisa for a child you cannot access that money again. For cash Jisas the child can take charge of the account at 16. For stocks and shares Jisas, the account holder can access the money once they turn 18.

The alternative, if the child does not need the money, is for them to roll it over into an adult Isa when they reach the age of 18.

Q. Can I move my investment into an Isa?

If you hold shares or funds in an investment account, you can sell them and reinvest the proceeds in an Isa. This is known as 'Bed & Isa'. This way you use existing money or investments to take advantage of annual tax allowances rather than having to find new money, which may not be available.

You have to use this route as you cannot transfer existing holdings directly into your Isa. The holdings must be sold in one transaction, and then bought back within an Isa wrapper, in another. There are likely to be transaction costs involved, but the increased allowance means more of your money can grow indefinitely free of tax, so it's well worth making use of your allowance each tax year.

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