How much money can I put into an ISA each year and is it worthwhile doing so as a lower rate tax payer?
There are three main types of ISA, and the maximum contribution for each is different.
In a single tax year you can either have a Mini cash ISA and a Mini Stocks & Shares ISA or a Maxi ISA. You cannot start a new Mini and a Maxi ISA in the same tax year. The maximum contribution for a Mini Cash ISA is £3,000, it is £4,000 for a Mini Stocks & Shares ISA and £7,000 for a Maxi ISA. Both routes allow you to put up to £7,000 into an ISA.
For a basic or higher rate taxpayer, using your Cash Mini ISA allowance makes sense from an income tax point of view. You will save either 20% or 40% income tax from your savings interest as a result. For the Mini Stocks & Shares ISA and the Maxi ISA, the tax arguments are less clear cut.
As a basic rate taxpayer there is little income tax advantage from holding Stocks & Shares within an ISA. The ISA fund manager can no longer reclaim the 10% tax credit (which isn't really a credit but an income tax charge) on UK dividend income. This means that your equity holdings get treated the same either outside or inside the ISA. A higher rate taxpayer does avoid paying the additional higher rate income tax on this dividend income when they hold their equities within an ISA. Other types of investments, such as fixed interest securities, provide a better income tax argument for the ISA, because they are completely free of income tax on the interest they pay.
From a captial gains tax point of view, holdings within an ISA are tax free. However, each individual gets an annual capital gains tax exemption (£8,800 in the 2006/07 tax year) and many people don't use this anyway, so the capital gains tax advantage within an ISA might be marginal at best.
The other form of tax to consider is inheritance tax. Investments within an ISA cannot be sheltered from inheritance tax as they fall back into the investors estate on death.
What attracts a lot of investors to an ISA is not the tax savings at all, but the reduced paperwork! If you hold investments within an ISA then you do not have to report any income or gains to the taxman, which can save the completion of a few forms each year.
(Information is intended for guidance only and is offered without any legal responsibility. None of the information provided constitutes any form of recommendation and is not intended to be relied upon by you in making any investment decision. You should always obtain independent professional financial advice before making any investment decisions).