ISAs ñ A free lunch from the taxman

There are not many free lunches to be had from the taxman so it makes sense to tuck in when there is one on offer. Individual Savings Accounts or ISAs have long been a feature of the savings landscape but they will shortly become even more attractive.

An ISA is a wrapper for funds that may be invested in either cash or stocks and shares free of both income and capital gains tax. From April 6, the start of the 2008/2009 tax year, the ISA rules will be simplified and made more flexible while the amount that can be invested will be increased. These changes represent the most far-reaching reform of ISAs since they replaced Peps and Tessas in 1999.

The most readily quantifiable element of the changes is an increase the sum that can be invested annually in a cash or money market account from £3,000 to £3,600. The maximum overall investment, including stocks and shares, has gone up from £7,000 to £7,200. These are much smaller increases than many advisers and building societies had been calling for but they represent a welcome boost.

At the same time, the terms Mini and Maxi ISA will be abolished in favour of Cash and Stocks & Shares ISAs. Apart from removing a confusing bit of jargon, this change will give greater flexibility in allocating funds between cash and securities. Under the current regime a contribution into a cash ISA limits your investment in stocks and shares to just £4,000. If no separate Cash ISA is established you can invest up to £7,000 in stocks and shares. Under the new rules savers can mix and match. A £1,000 investment in cash could, for example, be accompanied by up to £6,200 in stocks and shares.

From April 6 savers will also be able to transfer their Cash ISAs into Stocks & Shares ISAs without eating into their annual subscription allowance. Another important change will allow savers to transfer funds paid into cash ISAs in earlier years to be transferred into Stocks & Shares ISAs. This means savers with a positive view of the mid to long-term outlook for equities can take a ride on the possibility of higher returns. But be warned, if shares prove disappointing, you will not be able to switch your funds back into a Cash ISA.

Savers who have yet to take out an ISA in the current financial year can get some good deals before the regime change. ISA providers such as Kent Reliance Building Society, Loughborough Building Society, Scarborough Building Society and Icesave have been offering Cash ISAs at a fraction over 6 per cent in an attempt to lure in new customers before the end of the tax year. These rates mean the basic rate taxpayer can get more than one percentage point of extra return over an equivalent taxed investment while a higher rate taxpayer gets a boost of more than two percentage points.

Many building societies and financial advisers still think the sums that can be invested in ISAs are too low and they are calling for a higher annual maximum. But spread over many years a regular ISA contribution can build up a considerable tax-free nest egg and deliver attractive returns.

By Charles Batchelor

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