Pre the March 2007 budget the two types of ISA were:
Up until 5 April 2004 there were also TESSA-only ISAs or TOISAs which were created to allow the original capital (excluding interest) invested in a TESSA (up to £9,000) to be reinvested in a tax-free form. It was only possible to invest in a TOISA with the capital from a matured TESSA, and new TOISAs may be created for the complete transfer of funds from another TOISA.
A third component, the insurance component, was also available in both maxi and mini ISAs. However, since the 2005/06 tax year this component has not been available. Collective investment funds that once qualified for this component will have been reclassified as qualifying for either the Cash or Stocks & Shares component. The tax year in the UK is from 6th April to 5th April.
Any UK resident individual of at least eighteen years of age can invest in one 'maxi' ISA, with both components provided by a single financial institution. Alternatively, a person can invest in two 'mini' ISAs, one for each component (see above). The two mini ISAs may be with two different providers if the investor wishes. TOISAs and the full transfer of ISAs created in previous years to another provider have no bearing on these restrictions. With a few exceptions, such as from an employee share ownership plan, all investor contributions must be in cash.
UK resident individuals aged between 16 and 18 can also open a cash mini ISA or a maxi ISA, but can only allocate their investment to the cash component.
The amounts which may be deposited in an ISA in a tax year are fixed by law. For all years up to and including 2007/8, the limits have been:
In the March 2007 Budget, the limits from the 2008/9 tax year were increased (to allow for easier division over 12 months), and the distinction between a mini and maxi ISA abolished, as follows:
Interest on any cash held in the stocks and shares component is subject to a flat charge of 20%.
From 6 April 1999, advance corporation tax (ACT), payable by companies when they paid dividends, was abolished. Previously, under the imputation system of taxation, recipients of a dividend were entitled to a tax credit which reflected the payment of ACT by companies. This tax credit reduced the amount of tax that was payable by the recipient of a dividend and, where the recipient's tax liability was less than the tax credit, the excess could be reclaimed (particularly by non-taxpayers, such as charities, pension funds and PEPs).
From April 1999, companies have not been required to pay ACT, and dividends are accompanied by a 'notional' 10% tax credit. The ability of certain non-taxpayers to claim a repayment of this 'notional' tax credit was phased out from 6 April 1999 to 5 April 2004, effectively removing some of the originally tax-free status (although higher-rate taxpayers have no further liability which they would do on dividends held outside an ISA). The result is that a fund primarily used for income rather than capital growth is far less tax efficient (especially for non higher-rate taxpayers) when placed in an equity fund, whereas a fund based exclusively on other asset classes (such as bonds) continues to be tax-free in terms of income as well as capital growth.
Cash ISAs have nevertheless been beneficial to savers through providing instant access savings that require little investment, meaning that the first £3,000 of any cash savings each year will be in a tax-free environment. By way of contrast, only the interest could be withdrawn from a TESSA before its five year period had finished or the tax free status would be lost. Further, due to competition cash ISAs continue (as at September 2004) to offer the highest rates of interest, irrespective of tax status, often meaning £1 in an ISA gains a higher rate of gross interest than many thousands invested in another account with the same provider. The market is further advanced as non-taxpayers still benefit from the use of cash ISAs due to the favourable interest rates.
Many equity funds also meet the CAT standards, but the restriction on costs generally means that these funds are index funds, which require little management and simply follow a given index, such as the FTSE 100 Index.
The ISA cash component, like any savings account, is typically free of charges although some providers charge a fee for transferring to another provider.
The built-in annual "re-registering" of your ISA may attract a fee which may be automatically extracted from your account.
Collective funds in the Stocks and Shares component usually attract the same initial and annual charges as they would do if held outside an ISA.
Self Select Stocks and Shares ISAs, provided by a stockbroker, attract brokerage fees comparable to those outside an ISA. Many stockbrokers charge an additional fee for administration of the ISA.
Investors are only permitted to invest their Stocks and Shares component with a single financial institution in any year. For investments into collective funds, these institutions have traditionally been the fund management companies themselves. This creates a difficulty for investors wishing to diversify their investment into the collective funds of different fund management companies in the same year. It also means that investors wishing to transfer existing ISA holdings have to transfer the ISA itself between providers, which can be a time consuming process.
To avoid these problems, a number of Fund Supermarkets have been set up. These are organisations which act as ISA providers who offer access to a wider range of collective investments from a variety of fund managers. They allow investors to build a more diversified portfolio within a single ISA and to transfer their investments between funds without the complication and delay of changing ISA provider. Fund Supermarkets are promoted by many Independent Financial Advisers and have quickly become popular because they allow investors greater choice and flexibility at no extra charge. Instead of charging the investor, the Fund Supermarkets are paid by the fund managers out of their usual charges. The two largest Fund Supermarkets are Cofunds and Fidelity FundsNetwork.
A Fund Supermarket differs significantly from a true Self Select ISA provided by a stockbroker. The Fund Supermarkets do not offer the entire range of ISA eligible collective funds nor do they allow investment directly into specific stocks or shares.
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