How to start saving or investing into an Isa - the essential guide to a tax-friendly pot

By This Is Money
Updated: 03:27 EST, 13 March 2014

Making the most of your annual Isa allowance is the cornerstone of wise saving and investing. You'll pay less tax and your money will grow faster.

Here, we explain how to start using an Isa for your savings...

Cash Isas: The new financial year starts on 6 April

Cash Isas: The new financial year starts on 6 April

What are Isas?

Isas - or Individual Savings Accounts - are tax shelters into which savers can put a wide range of investments, from cash to stocks and shares and unit trusts.

There's no income tax to pay on interest and no capital gains tax on profits. This makes them ideal for long-term savings because money that is not taxed grows faster.

They're also good for retirement because any income taken from them is not taxed, so doesn't have to be declared to the taxman.

There are two basic types of Isa - cash and investment. You can contribute a maximum of £11,520 this tax year, which ends on April 5 2014.

From the start of the next tax year on April 6, you have a new allowance of £11,880 which you can put with the same or a different Isa manager - whether it be a bank, building society or investment company.

But if you don't use your annual allowance in one tax year, you lose it forever.

Up to half of the total (£5,760 this tax year) can go into a cash Isa and the remainder - or the whole amount — can go into an investment Isa. From next year this rises to £5,940.

Every UK citizen aged 16 and over qualifies for a cash Isa allowance, though the minimum age for an investment Isa is 18.

On 1 November 2011, Junior Isas were launched. These work in very similar ways to adult Isas but with a lower allowance - £3,600 a year - and no access to the cash until a child turns 18.

Even though Isa rates have fallen to record lows, it is important to top them up each year to maximise the amount you can shield from the taxman. This is Money editor Simon Lambert explains why Isas are important here.

Cash Isas

Cash Isas should be the first port of call for every saver who wants to make the most of their money and beat the taxman.

 
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They protect your savings by paying tax-free interest, unlike most savings accounts where the bank or building society deducts 20 per cent tax from the interest.

To put that into context, that means that before you even see any interest on your hard-earned savings, the Government pinches 20 per cent.

Follow our easy steps to opening one:

1. Do your research

There are hundreds of cash Isas at banks and building societies, all with different terms and conditions. Some offer easy access so you can get at your money whenever you need it. Others pay a fixed rate if you leave a lump sum untouched for a year or more.

Some banks offer great deals to new savers with a bonus, but then cut the rate after a few months or a year. Open these only if you are prepared to monitor your interest rate and move your money. You are only allowed to open one new Isa each tax year but you can also transfer existing savings to other Isa accounts.

Find the best Isa rate for you in our savings tables updated daily and our five favourite Isa list updated when better deals become available:

>> Best cash Isa rate tables

>> This is Money's Five Favourite Isas

2. How much do you want to save?

Each tax year you can save a set amount into a cash Isa, when this tax year ends and a new one starts you can put more into it, or open another Isa and save into that. You can put up to £5,760 into a cash Isa in the tax year 2013/14.

You can either put this money in as a lump sum, or save regularly into the Isa. Many fixed term Isas will only allow you to pay in once, other easy access Isas, or regular savers let you pay in over a period of time.

Remember £5,760 is £480 a month, a savings sum beyond what many people will put in, so you can put in plenty each month before you hit the limit.

›› Use our long-term savings calculator

3. Check for catches

Once you have chosen your Isa read the terms and conditions carefully. Are you trapped in a variable rate account where the bank can change the interest but you have to wait several weeks or even months to get out? Will the rate tumble in a year? Are there charges for transferring elsewhere or making withdrawals?

4. Get your documents ready

To open an Isa you need to provide certain identification. You need:

- Your National Insurance number - it's on your tax form or pay slip.

- Identification of both who you are (a driving licence, passport, a letter relating to your pension or HM Revenue & Customs Coding Notice) and where you live (a bank or building society statement or utility bill - not a mobile phone bill - no more than three months old or your latest council tax bill).

- For telephone or internet accounts, you have to send the above documents in the post.

5. Apply and don't delay

Every year savers end up in an Isa jumble as banks face a last minute rush for accounts. If you see an account you like then apply well before the deadline on April 5 - this lessens your chance of missing out.

Plus: Transfer your old Isa

It's highly likely that your old Isa may no longer be up to scratch. Banks and building societies tend to offer the best rates on new deals and let old ones slide.

Typically, an instant access account will drop below one per cent after a year.

Once fixed-rate deals expire, the account is often flipped into an instant access deal. Many pay as little as 0.1 per cent.

Find a new home for your Isa cash by hunting out a good rate that accepts transfers, then get your cash moved. You do not have to make the transfer to the same Isa that you put this year's Isa allowance into

How to transfer an Isa

- Check that the bank or building society accepts transfers.

- Fill in an application form from your newly-chosen provider and get it to arrange the transfer. You will have to provide proof of identity.

- If you apply before the end of this tax year (5 April) and have opened a cash Isa in the current tax year (April 2013 to April 2014), you have to transfer the lot to the new provider.

- On cash Isas opened before April 6, 2013, the Isa rules allow you to transfer part or all to a new provider, or transfer part to several providers. You can split it between variable rate and fixed rate deals. But not all providers accept or allow 'partial' transfers.

- Full guide to transferring an Isa (and how to complain if it goes wrong)

Investment Isas

How it works

With an investment Isa account you can hold stock market-type investments such as shares and funds. The investments held within the account, as with a cash Isa, are allowed to grow tax-free.

You can also have corporate bonds and gilts (government bonds) in an Isa account. Bonds pay a fixed rate of interest and, if the company is sound, will pay the money back on a pre-agreed date. The interest paid by the bonds is free of income tax if they are held in an Isa.

The tax incentive

Money put into an investment Isa also benefits from tax perks.

Capital Gains Allowance means outside an Isa, any investment gains over £10,600 in a year could be taxed at 18 per cent or 28 per cent, depending on whether you are a basic or higher-rate taxpayer.

Remember, though, this means any gains below this level are paid out free of tax whether they're in an Isa or not.

Within an Isa there is no tax to pay on any profits when you sell. At all. You won't have to pay any more tax on the income either. Outside an Isa, income on corporate bonds is taxed at 20 per cent, 40 per cent or 50 per cent, depending on your tax status.

With dividends on shares, it works differently. Some tax is deducted before they are paid and this can't be reclaimed. But higher-rate tax payers avoid having to pay a further 25 per cent.

Getting your investments on track

The aim is to pick funds, and/or individual shares and bonds that are likely to deliver high returns for the lowest risk - but that also carry low charges.

The aim is to pick funds, and/or individual shares and bonds that are likely to deliver high returns for the lowest risk - but that also carry low charges.

For the 2013/14 tax year, once you are aged 18 and over, you may invest up to £11,520 into your stocks and shares Isa, less any money saved in a cash (up to £5,760).

From 2014/15, this limit will increase to £11,880.

Independent financial advisers can help pick these, but you will pay the full charges on funds in return for this advice (these fees are discounted by a fund supermarket).

Some experts argue that novice investors should begin with index trackers, low-cost funds that mirror the stock market, or global investment trusts.

You may feel more comfortable using an adviser to help you make your decision.

- See our complete guide to Isa investing