In July, ISAs experienced one of the biggest overhauls in their history.  Many people were already confused by the very concept of what they are, and since the introduction of the new rules, the waters have been muddied still further.  As a result, a lot of people have chosen to steer clear of them, failing to understand the many benefits an ISA can offer.

This decision is not financially savvy.  ISAs carry many advantages, offering tax-free and tax-efficient ways for ordinary people to invest.  They can substantially increase your returns and there is, perhaps surprisingly, no real downside to them.  Isn’t it time that you considered investing?

ISAs Explained

One of the most commonly stated motivations for failing to take advantage of an ISA is that people don’t understand them.  In truth, the concept is a simple one.  Imagine your wealth as biscuits.  Your stocks and shares are bourbons, and your cash is custard creams.  Each time the taxman visits you put your biscuits on a plate and let him take what he wishes.  An ISA is like a cake tin: it allows you to keep back some of your biscuits rather than offering them all on your plate.  This may sound rather suspect, but it’s all completely legitimate; the powers that be themselves have given you the tin in order to encourage you to save.

Each tax year, you’re awarded an ISA allowance.  This is the amount that you can hold in your ISA account (your biscuit tin) between April and April.  It used to be the case that there was a limit to how many bourbons and how many custard creams (stocks and shares, and cash) you could hold in it, but these rules have been completely relaxed.  Although the limit still exists, you can split this amount as you choose between stocks and shares and cash ISAs, or use it all for one or the other.

For the year 2014 to 2015, this threshold was set at £15,000.  From April of this year, it will rise to £15,240.  In order for the investment to count for your chosen year, it must be saved or invested by 5th April.

At the end of each year, you’ll be awarded a new allowance.  This does not impact any existing ISAs that you have; they remain tax-free and continue to earn interest until they’re withdrawn.

Growing Free Money on Flowers by epSos .de, on Flickr.  This work is licensed under a Creative Commons Attribution 2.0 Generic License.

Reasons to Invest in an ISA

Cash ISAs have many financial benefits attached to them.  One of the most advantageous is that they allow investors to hold substantial amounts tax-free.  For example, you could have invested £7,000 per year from 1999 to 2008, £7,200 per year until 2010, £10,2000 for 2010/2011, £10,680 in 2011/2012, £11,280 for 2012/2013, £11,520 for 2013/2014 and £15,000 for 2014/2015, plus any gains made year on year.  If you had instead chosen a standard instant access savings account, you would have paid 20 percent on any interest earned as a basic rate taxpayer, 40 percent as a higher rate taxpayer, and 45 percent as an additional rate taxpayer.  As your interest isn’t taxed, this means that in almost every instance, you’ll be earning more in interest than you would on a normal savings account.

Stocks and shares ISAs also have many benefits.  Although they’re not tax-free like cash ISAs, there are three major tax advantages attached to them.

Firstly, you won’t pay tax on any profits that you make.  If you invest outside of an ISA, on the other hand, you’ll be obliged to pay between 18 and 28 percent, depending on your tax band, for any profits above the annual capital gains tax allowance.

Furthermore, you won’t be obliged to pay tax on any interest earned on bonds, meaning that you get to keep any revenue in its entirety.

Finally, there is a 10 percent tax cap on income.  Although basic rate taxpayers would pay the same on income earned from share investments outside of an ISA, this is a significant saving for higher and additional rate taxpayers, who would otherwise pay 32.5 and 37.5 percent respectively.

So, what are you waiting for?  Invest in an ISA today.