What is an ISA?

If you have some spare cash and you are thinking about investing it, then an Individual Savings Account (ISA) should be at the top of your list.

ISAs were introduced by the Labour government to replace Personal Equity Plans (PEPs), and have very good tax-free benefits.

In order to qualify for an ISA, you must be a UK resident and 18-years old or above - although at the age of 16 it is possible for you to take out a cash ISA.

It is important to understand that an ISA isn't an investment. It is actually what is known as a 'wrapper' in which you can house your savings and investments. The structure of ISAs are simple, they are made up of two elements - cash and stocks and shares.

The options

The cash element of an ISA is exactly that. So how does it work? Well it is usually linked to a form of deposit account.

The other option is a stocks and shares ISA. This covers many investments such as investment funds, government gilts and corporate bonds.

There are limits to how much you can invest in your ISA each tax year and this is dependent on which form of ISA you choose.

Currently ISAs are split into two different categories - the maxi and the mini, and this is where it can get a little confusing.

You can invest in one Maxi ISA or two different mini ISAs in any one tax year, but you can't put your money in both types in the same year.

A mini-ISA separates out the two elements, so that you take out either a cash mini-ISA or a stocks and shares mini-ISA. You can invest in both types in the same tax year, but you can't choose two cash mini-ISAs or two stocks and shares mini-ISAs. The annual maximum investment limits for mini-ISAs are £3,000 for the cash version and £4,000 in a stocks and shares type.

Maxi-ISAs are more straightforward than their mini counterparts. You can only invest in one each tax year, but can invest up to £7,000.

However, this is all about to change on 6 April 2008. The new tax year will see ISAs become much simpler - there will no longer be a mini-maxi option. Instead you can choose to invest in a cash ISA or a stocks and shares ISA.

The maximum limits of investment per tax year is also set to rise. The stocks and shares ISA will have a maximum limit of £7,200 and the cash element will rise to £3,600. You will also be able to transfer your cash ISA into a stocks and shares ISA (although not the other way round).

Tax benefits

You don't pay any tax on any interest, dividends or bonuses you make from your Isa.

However, since April 2004, Isa holders don't recieve the tax credit on dividends from UK companies. There is already no tax credit on dividends from companies outside the UK.

If you have a stocks and shares Isa and it increases in value, you will not have to pay Capital Gains Tax (CGT) on the increase. And finally, you do not have to include your Isa on your UK tax form.