To qualify to take out an ISA, you have to be UK-resident and over the age of 18, although it is possible to take out a cash mini-ISA if you are over the age of 16.

An ISA is not in investment - it's a wrapper into which you can put your savings and investments.

ISAs comprise two elements: cash, and stocks and shares. The cash element is just what it says it is, usually linked to some form of deposit account, whilst the stocks and shares element actually covers a wide range of investments, including investment funds and fixed-interest securities, such as UK government gilts and corporate bonds.

ISA limits

There are limits on how much you can put into an ISA in any one tax year, and the amounts you can invest will depend upon the type of ISA you are taking out.

There are two different types of ISA, mini-ISAs and maxi-ISAs. You can invest in one maxi or one or two different mini-ISAs in a tax year, but you can't invest in both types in the same year.

A mini-ISA separates out the two elements, so that you take out either a cash mini-ISA or a stocks and shares mini-ISA. You can invest in both types in the same tax year, but you can't choose two cash mini-ISAs or two stocks and shares mini-ISAs. The annual maximum investment limits for mini-ISAs are £3,000 for the cash version and £4,000 in a stocks and shares type.

Maxi-ISAs are more straightforward. You can only invest in one each tax year, but can invest up to £7,000.

Tax advantages

Investments held within an ISA are not liable for capital gains tax (CGT), nor do any dividends you receive from them have to appear on your income tax form.

However, the income element is not as attractive as it used to be. Until April 2004, all the income generated within an ISA was tax-free too, but now only fixed interest (ie a bond) and cash investments remain entirely free of tax.

Basic-rate taxpayers have to pay 10 per cent tax on equity income regardless of whether this is held inside or outside an ISA, although you will not notice this happening as the deduction is made within the fund or direct from the share dividend.

There is no further tax to pay, so ISAs remain attractive for higher-rate taxpayers.