ISAs: A guide

Individual Savings Accounts have become increasingly popular due to their tax free limits and the variations within the ISA umbrella. ISAs provide tax free savings in cases where most people would have to pay 20% tax as a basic rate upon their savings account. This tax free allowance does have a limit, but with a limit of up to £10,720 in a stocks and shares ISA and £5,340 in a cash ISA, they do have the level of tax relief that the majority of savers are looking for when taking out savings accounts.

They come in two main forms - cash and stocks and shares ISAs. The two differ greatly in interest rates, tax free allowance and also in the availability to access all of your funds.

Taking out cash ISAs are the most simple - you can invest up to £5,340 per tax year without paying any tax on your savings. Most cash accounts are flexible and there is the availability to access your money easily and without much of a negative effect on your savings. Although the accessibility of these ISAs adds to their appeal, their interest rates do let them down.

Stocks and shares ISAs have a different make up. The tax free limit is £10,680. Although you can invest more per tax year in these, you can only invest the cash allowance (£5,340) in cash form. The rest of your investment must be put into shares. Some of these are risky and usually return higher interest, others are much more stable, but with stability comes a lower interest rate on your funds placed into shares. The choice of which shares to invest in should be made with the advice of a financial adviser or bank or building society representative. They are always happy to help give advice as to what investment would be best for you.

The interest rate is usually tracked from the Bank of England base rate, and this is currently at an all-time low. This had an impact on many financial products which have also seen interest rates plummet in reaction to the Bank of England base rate drop. You may find that some do offer high savings interest rates, these may tie you in for a fixed period or they may decrease significantly after the first year of taking out the account.

These are the basic facts about ISAs, but interest rates and terms of each of the accounts depend on the product terms, which are determined by the product provider.

Fixed rate ISAs do currently have the most appealing savings interest rates. These fixed rate versions have not historically been the most popular or the best savings accounts but they have increased in popularity in recent years. This is due to the fact that the interest rate that is paid on most has decreased significantly in the last couple of years. This is because they are based at a few per cent above the Bank of England base rate and this rate is at an all-time low.

Fixed rate ISAs hold all of your investment in cash. As the rate is fixed, the product provider can determine the rate of interest paid on cash but not on the behaviour of stocks and shares, for this reason, you can only take out a fixed rate account as cash. With one of these, there will be a fixed term that you need to have your money invested in the account to receive the fixed rate return. There will also be a minimum amount that you will have to invest. This is usually the case with most accounts, whether they are cash or stocks and shares, although if you take a fixed rate will usually require a larger first payment than the cash equivalent.

The best savings accounts when taking into account savings interest rates are currently fixed rate ISAs. This is because of the rate of interest is currently higher than taking out a tracked rate version. You should bear in mind, however, that the Bank of England base rate is not likely to decrease any further and with this being the case, the rate of interest paid on a tracked cash or stocks and shares ISA will increase in the future. You may not have the ability to transfer your funds from a fixed rate to a tracked rate account once this happens and you may be tied into your fixed rate for some time. Most of the fixed rate accounts that are currently available are for between one and five years, with the interest rate looking healthier and more substantial the longer you agree to keep your funds invested in the account for.

When looking for the best savings account for you, you should look at the likelihood of the interest rate changing on the account you hold. You should look at trends and take advice as to whether it's likely to increase or decrease in the time you have your cash invested.

This is one of the main issues with holding either a tracked or a fixed rate ISA. Both have the ability to go above and beyond your expectations, either when the interest rate rises when you are on a tracked rate or if it falls and you have taken a fixed rate. They do, on the other hand, have the opportunity to go in the other direction. You may have a tracked rate and this can fall as we have seen in the past three years, or you could have a fixed rate that seemed great when you set up the policy that is now underperforming in relation to a tracked rate account.

Summing up interest rate possibilities and working out which is the one for you at the time you invest is crucial to making the correct decision.