Why ISA Savings Make Sense

By Gemma Stanbury

Anything that allows you to make use of your own hard-earned cash before the taxman is able to get his hands on it must be a good thing. That is why ISA savings may make sense for you (i.e. if you are a tax payer).

Whatever is happening with commercial rates of interest in the market, an Individual Savings Account - or more specifically, a cash ISA - is likely to keep you ahead of inflation simply because of the tax-free concession made by the Inland Revenue.

Although the maximum permitted savings in a cash ISA are a relatively modest £3,600, anyone with the intention of maintaining some level of savings may do well to keep this tax-free vehicle amongst their first ports of call. As banks and building societies continue to compete for savers' available cash, attractive rates of interest continue to be offered for cash ISAs.

Savings are secure in a cash ISA because the amount deposited is returned, along with the interest, at the end of the year in which it is bought. It is a genuinely tax-free savings account. And although it is possible for you to withdraw cash invested in a cash ISA, once it has been withdrawn it is not possible to reinvest the same sum to "top up" the ISA during the current year.

Furthermore, just as with many regular savings accounts, penalties by way of lost interest can be imposed for making such withdrawals. By the same token, do be aware that the advertised rate of interest might include a "bonus" which will be paid only if you make no withdrawals from your ISA savings during the year. So, when looking to invest in an ISA, do check out the terms and conditions relating to withdrawals etc.

The benefits of a cash ISA can be cumulative, too. At the time of writing (July 2008), the annual allowance is £3,600. At the end of the financial year, however, any existing cash can stay in the ISA and a completely new allowance is granted, so that a further £3,600 can be purchased.

Cash ISAs can be bought with either a fixed rate of interest, determined at the outset, or with a variable rate that the provider changes broadly in response to variations in the Bank of England base rate. Since this can make a previously competitive ISA less so, after a variation in the rate, it might be necessary to switch the savings to a different ISA provider to maintain the best rate.

For those investors prepared to take a greater risk with their savings, equity ISAs can also be purchased with the remaining £3,600 of the total £7,200 ISA allowance, or the whole of the £7,200 can be invested in to an equity ISA. As the name suggests, this Individual Savings Account rests on the purchase of a provider-managed portfolio of stocks and shares. Returns, in the form of dividends, will therefore depend on the performance of the equities held by the portfolio managers, as will any capital gains at the end of the year when the ISA reaches its term.

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