BrilliantWithMoney

Since their birth in April 1999, Individual Savings Accounts (ISAs) have been through a number of changes. The latest set of changes announced in the Budget this year see the annual allowance increased from £7,200 to £10,200.

As things stand, you can save or invest up to £7,200 within the ISA tax wrapper in a single tax year. Of this, up to £3,600 can be saved in a single cash component – a cash ISA. The balance, up to £7,200, can be invested in the stocks and shares component.

This means that if you used the full £3,600 cash ISA allowance you can only invest £3,600 in a stocks and shares ISA in the same tax year. Alternatively you could invest up to £7,200 in a stocks and shares ISA with nothing in a cash ISA that tax year. Or you could do anything in between.

New limits

The new £10,200 annual limit comes fully into force on 6th April 2010 for the start of the 2010/11 tax year. However, if you are 50 years old before 6th April 2010 you can take advantage of the new higher allowance in the 2009/10, from 6th October 2009.

This new annual ISA allowance works in much the same way as the old £7,200 limit – up to half can go into cash and the balance of the allowance can go into investments within the ISA tax wrapper. This means a maximum of £5,100 in the cash ISA component and the balance in the stocks and shares component.

It might look like a generous increase in the ISA allowance, but if the annual ISA allowance had kept pace with average earnings since 1999 it would already stand at £10,500.

Added PEP

Before we had ISAs, we had PEPs – Personal Equity Plans. These were very similar to stocks and shares ISAs and existing PEP accounts continued to run alongside the new ISA accounts for a while. The rules surrounding PEPs were brought into line with ISAs in April 2001 before they automatically became stocks and shares ISAs in April 2008.

Tax treatment

An ISA is a tax efficient tax wrapper, but this tax efficiency depends on the investment held within the wrapper.

In general terms, income and capital gains on investments within an ISA are free of tax. However, the abolition of advance corporation tax (ACT) in April 1999 means that the 10% tax credit on UK dividend income cannot be reclaimed on investments within an ISA. This means it cannot be said that an ISA is always free of income tax.

The Government has guaranteed that the tax efficient status of ISAs will continue until at least April 2010, and it seems likely given the recent increase in annual ISA allowance that the tax status will remain unchanged for several years after that.

Moving ISA money around

It is perfectly possible to move money between ISA providers without losing the value of your ISA allowance, but you need to be aware of some rules.

Since April 2008 it has been possible to move from a cash ISA to a stocks and shares ISA. Unfortunately you cannot move your ISA money in the other direction. This means that it is possible to take more risk with your ISA money but not to move investment funds to a cash ISA within your ISA wrapper.

You can invest in cash within the stocks and shares ISA as long as it is only a short term measure. Interest paid on cash within a stocks and shares ISA is subject to income tax at 20%, which removes the income tax efficiency of the ISA wrapper for basic rate tax payers.

Only ISA managers can transfer ISAs. If you try to do this yourself, it will be treated as a withdrawal and you will lose the related ISA allowance. If you want to move money between providers then you should ask your ISA provider for the relevant transfer form and let them process this on your behalf.

You can transfer part of a previous tax year ISA to a new provider but if you want to transfer the current year ISA you have to move the whole lot at once. Partial transfers of your ISA for the current tax year are not permitted.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.