Why everyone should have an Isa

In the last few years, trying to build, or even just protect, wealth has not been easy, as high inflation and low interest rates meean the real (after inflation) value of your wealth is eroded. But that’s even more reason to put as much money as you can into an Isa, says James McKeigue.

If you've visited a bank or a financial website recently, or just switched on a TV, you'll have noticed that it's individual savings account (Isa) season again. The end of the tax year is here and banks and brokers are all trying to convince you that they've got the best Isa.

But don't be fooled when it comes to picking the right deal, you really have to make sure you've compared all the options and read the fine print. That's why we write this guide every year. We've gone through the details for you and unearthed the investment options that should get the most from your Isa allowance.

In the last few years, trying to build, or even just protect, wealth has not been easy. Stockmarkets have turned volatile and US and UK government bond yields have sunk as investors haved piled into safe havens. In more normal' times, that might encourage investors to seek the protection of a bank account. Unfortunately, high inflation and low interest rates make it difficult to find an account that can stop the real (after inflation) value of your wealth being eroded.

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But that's even more reason to put as much money as you can into an Isa. According to figures from Moneysupermarket.com, basic-rate taxpayers using a cash Isa would have earned £14,504 in interest if they had opened one every year since they were first launched 12 years ago. That is £3,354 more than someone who has saved in a regular savings account. No surprise, then, that there are now more than 17.5 million Isa savers in Britain, with £143bn in cash funds. Yet, despite the advantages, many British savers aren't using their Isas properly. Research from financial advice group Unbiased.co.uk shows that every year British savers give £509m to the taxman that could be safely protected. Why? Time to dispel three myths that may be holding people back.

Three myths about Isas

Isas are inflexible

Many people think putting money in an Isa means locking it away for years. But that's not true. There are all sorts of accounts that can be opened within an Isa and many have no withdrawal notice periods. Likewise, you can sell your holdings in a stocks and shares Isa whenever you want.

Isa providers offer rubbish rates

While that is sometimes the case, there are plenty of good offers out there. On page 4 we go through the best cash Isas and show where you can make the best return.

Isas are restrictive

Again, this is not true. There are some limitations, for example you can't stick some foreign shares in an Isa. But the list of what can go in is pretty lengthy. On page 6 we cover exactly what can and can't go in.

How an Isa works

The single biggest point of confusion with an Isa is that it is not an investment. It's a tax-efficient wrapper that shields your savings and investments from both income tax and capital gains tax. You pick an investment that the government deems eligible more details on that on page 6 and then shield it with an Isa.

Unfortunately, an Isa can't take away the 0.5% stamp duty levied when you buy shares, although we highlight one stamp-duty-free investment on page 10. An Isa can't protect you from inheritance tax either.

The government doesn't want too much of the public's money kept out of its reach so it sets a limit on the amount that each person can put into an Isa each year. At present that limit is £10,680, but that will rise to £11,280 from 6 April 2012.

That money can be split between two types of Isa. The most popular is the cash version, which makes up around four-fifths of all Isas. Think of it as like a normal savings account but with no income tax deducted from the interest you receive. These are a nice safe option, but the maximum amount that can be put into a cash Isa is £5,340. That will rise to £5,640 from 6 April 2012. Anyone over the age of 16 can open this type of Isa.

The other option is a stocks and shares Isa. These can take the full annual investment limit minus any money you have put into a cash Isa in the same year. However, because these are riskier you have to be at least 18 to open one. You can then have a cash Isa with one provider and a shares account with a different one.

However you decide to use the allowance, it's use it or lose it. So get ready to invest now.

James McKeigue

James graduated from Keele University with a BA (Hons) in English literature and history, and has a certificate in journalism from the NCTJ. James has worked as a freelance journalist in various Latin American countries.He also had a spell at ITV, as welll as wring for Television Business International and covering the European equity markets for the Forbes.com London bureau. James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report. He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.