Seven top cash ISAs and five good shares ISAs

We pack in the details about two types of savings account that you should be using.

When we put money in a savings account, the bank automatically deducts 20% tax on interest earned and pays it directly to the taxman, and higher-rate payers also have to pay extra through their tax returns. Non-taxpayers have to complete a form to stop the bank taking the tax.

When we invest through a share-dealing account or in investment funds, there are a variety of taxes to pay on those investments, including stamp duty, income tax and capital gains tax.

To eliminate – or at least massively reduce – the tax that you pay on your savings and investments, it’s best to go for an ISA. If you're saving for the short-term, a cash ISA is for you. If you're saving for the future, you should consider a regular monthly investment in a shares ISA: the low-tax share-dealing/fund account. 

Cash ISAs

You're allowed to put £5,340 into a cash ISA this financial year (which ends on 4th April 2012). This limit will increase each April. If you don't invest one year, you lose that allowance forever. Also, if you withdraw cash from your cash ISA, you lose that part of your allowance forever, but you can put money back in the following year. 

Transferring from one cash ISA to another to stay on top of the best deals does not count as a withdrawal. This is useful, since you usually need to swap roughly once a year to keep getting a decent rate, just like with ordinary savings accounts. The alternative is to give away even more money to your bank through lost interest.

You get a variety of types of cash ISA, much like you do savings accounts:

There is easy access, which means you can take money out of your cash ISA whenever you want, so thes are suitable for emergency savings. (But remember you can't put it back in again after withdrawing it.) This type of cash ISA usually has variable interest rates, but look for fixed-rate bonuses: these frequently misunderstood and maligned guarantees ensure that the interest you receive won't fall below a certain level for a specified period, usually one year.

Watch out for fake "easy-access" accounts, which penalise you for making more than one or two withdrawals per year.

Then you get fixed-rate cash ISAs, normally for a fixed term of one to five years. These will almost invariably penalise you if you try to access the money early. You should expect an increasingly large interest rate the longer your money is tied up for. A five-year fix should be far higher than an easy-access account, for example. Currently, there are no long-term deals that I think are screaming buys, so I think most people should stay more flexible.

Top cash ISAs

Best available online (no offline account is substantially better). Some accounts are place higher on the table due to better guarantees. Excluding accounts with onerous conditions or that are exclusive to relatively small groups. Compare cash ISAs at lovemoney.com 

Share ISAs 

Investing is not about merely keeping up with inflation, but actually making more than rising prices. If you beat inflation by just a few percent per year, on average, you've doing just fine. This becomes increasingly more probable the longer you can invest for, but over short periods investing is always riskier than keeping cash. Some say invest for at least five years. I've always said at least ten years is more sensible. At least.

You can invest £10,680 in a share ISA this year, minus what fresh money you put into a cash ISA. Otherwise, you have to watch and compare all the costs, much like any share-dealing or fund account.

If you stick with regular investments in low cost share ISA funds such as index trackers, and ignore the rises and falls in the market, you aren't likely to become a billionaire, but you are highly likely to beat the vast majority of your peers, whether they use funds like you, or pick shares themselves, or even if they have financial advisers helping them.

Share ISAs are usually called tax free, although the truth is you do pay some taxes. A little income tax is taken automatically from your account and you pay stamp duty of 0.5% when you buy UK shares, for example. Yet you pay less income tax than you would in a normal account, and you pay no capital gains tax whatsoever, regardless of how big your gains become.

An additional advantage to using a share ISA instead of the plainer share accounts is it stops you incurring trading costs and potential missed gains by trying to sell early to avoid taxes, and then buying back again some time later, when the taxman allows it. Also, since you lose your ISA allowance if you withdraw your money, this makes you think twice before spending your investments on a whim. It's a good system, for those who can afford to invest these days anyway.

A selection of UK index tracker funds (FTSE All Share) 

Source: The Motley Fool and SCM Private. Funds ranked by how well they have tracked the index in the past decade, after costs. Legal & General's tracker has the bonus that the company doesn't lend out your shares to other people, a common practice in the industry that could make them more risky. Nor does it function in a common way that has a similar risk to lending shares (called synthetic tracking). I don't know if the other funds use these methods because most don't shout about it, so you should ask them before investing if their funds interest you. Please consider spreading your investments among a variety of foreign trackers too, which reduces your risks even more over the long term.

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