Confused about ISAs? You're not the only one. Here are all the facts you need to know.
There's a whole lot of confusion about ISAs and how they work. In a nutshell, an ISA is simply a way you can save cash or invest and pay less tax.
Do don't be put off by the jargon. An ISA is just like any other savings account or investment, except it has a 'wrapper' which you can put round your assets to provide the tax benefits. An ISA wrapper around a savings account, for example, transforms it into a Cash ISA which then pays interest, tax-free, on your savings with a bank. An ISA wrapper around stocks and shares means you don't pay tax on your capital gain from stocks and shares.
But we'll admit the many ISA rules do complicate matters. Take a look at these top ten myths and check out the real ISA facts:
1. You can only choose stocks & shares or cash
This is totally untrue. You can open a stocks & shares ISA and a Cash ISA in the same tax year if you want to. What's more, you can even choose a different ISA provider for each one. It's totally up to you.
Just remember the total ISA allowance is currently £10,680 (rising to £11,280 on 6 April), of which no more than £5,430 can be put in a cash ISA (rising to £5,640 on 6 April).
2. I have to put all my ISA money in one place
This isn't true either. If you choose a stocks & shares ISA you should be able to mix up the way your money is invested. For example, you can choose a range of funds which provide exposure to different markets around the world. And you don't have to stick to one type of asset either. Instead you can balance your investment across shares, bonds, property and cash. This will help to spread risk and diversify your savings portfolio.
You can also switch from a Cash ISA into stocks & shares, which although more risky will give the potential for a better return. You can't, however, switch from shares to cash.
Don't forget, you can move old ISA money around as much as you like. Look out for the Cash ISA best buys and top performing stocks & shares ISA which accept transfers, so you can always keep your money in the most competitive place.
3. Cash ISA rates are so low, I'd be better off with a traditional savings account
A quick look at current returns should easily resolve this one. In the red corner we have the Coventry Building Society Online Saver. This is a market-leading easy access savings account which pays a top rate of 3.15%. In the blue corner we have the AA Internet Access ISA, a market-leading instant access cash ISA with a rate of 3.5%.
Although the difference between the interest on the two accounts isn't huge, the difference becomes far greater when we take tax into consideration. The AA ISA offers a tax-free rate, whereas the Coventry account is taxable. The net rates (the rates after tax) are actually just 2.52% for basic rate taxpayers and 1.89% for higher rate taxpayers. I think that's Round 1 to cash ISAs!
4. Opening an ISA is complicated
Have you ever actually seen an ISA application form? They're usually no more challenging than two pages of pretty straightforward stuff. Questions like: what is your name, address, national insurance number... nothing too difficult. And the same applies to ISA transfer forms too. You can handle that!
5. The best time to open an ISA is at the end of the tax year
You've heard of the ISA season, right? This is the time where floods of ISA applications are made in the run up to 5th April, the end of the tax year deadline. But there's no reason why this is a better time to invest than any other. In fact, by using your new ISA allowance on 6th April, the first day of the tax year, rather than 5th April, the last day of the tax year, you can take advantage of a whole extra year of tax-free saving or investing.
6. I'll have to declare ISAs on my tax return
Quite simply, you don't. That's the point of an ISA.
7. ISAs are a better way to save for your retirement than pensions
This is a long-standing debate. But ISAs and pensions can actually be invested in very similar ways. And although the tax treatment of each of them is different - one is essentially the reverse of the other - it pretty much comes down to the same thing in the end. That said, some savers prefer ISAs because they can be accessed at any time, and there's no need to buy at annuity at retirement. Find more about that in Five reasons why ISAs are better than pensions.
8. ISAs are only suitable for big savers
You'll actually find many ISAs can be opened with just £1, making them suitable for both small and big savers. Some providers may ask for more, so make sure you check the minimum deposit before you sign up.
9. ISAs are only worth it for higher rate taxpayers
ISAs are exempt from income tax and capital gains tax, so it follows they will be more valuable to people who pay the most tax - i.e. higher rate taxpayers. But that doesn't mean they aren't beneficial to basic rate taxpayers, who can also reduce their overall tax liability.
10. ISAs are risky
Cash ISAs are just as safe as ordinary savings accounts. But there's always an element of risk when you invest in stocks & shares. And, ISAs are just a wrapper around the investments you have chosen. It's no more or less risky than investing in the same assets outside an ISA.
Finally, don't forget to check out our free ISA guides for more information.
This is a classic lovemoney article that has been updated
More on ISAs and savings:
Compare Cash ISAs
The UK’s best Cash ISAs
Top Cash ISAs for transfers
The UK's best Stocks and Shares ISAs
The one-year savings bond that offers a 5% return!
The UK's worst savings accounts