The top six ISA blunders

by Rachel Wait on 24 March 2011  |  4 comments
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If you're planning to open an ISA before the end of the tax year, make sure you don't make these mistakes...

ISA season is well and truly upon us. So if you’re thinking of topping up your current ISA before the end of the tax year, or you’re simply hoping to open one for the first time, here are six mistakes to avoid:

1. Not having an ISA in the first place

In my opinion, everyone should have an ISA. And that’s simply because an ISA is one of the few things in life that allows you to avoid paying tax.

Yes, that’s right, if you open an ISA, you can save your money and earn interest on those savings completely tax-free!

ISA interest rates may not look too inspiring right now (although rates have picked up over recent weeks), but if you take into account that you won’t have to pay tax on your savings, these rates suddenly look a lot healthier.

For example, the market-leading easy access cash ISA that’s available to everyone* is the AA Internet Access ISA which pays 3.35%.

In comparison, the top paying standard easy access savings account is the Nationwide MySave Online Plus Account which pays 3.05% - so already this is a lower rate. However, deduct tax from it, and the rate drops to 2.44% for a basic rate taxpayer and 1.83% for a higher rate taxpayer. So this is considerably less than the 3.35% you’d get from your ISA. You’d be mad to miss out!

2. Not using your full allowance each year

In the current tax year you can invest a total of £10,200 in an ISA. You can invest the entire amount in a stocks and shares ISA, or you can divide the amount between a stocks and shares ISA and a cash ISA – however, no more than £5,100 can be put into a cash ISA.

But the even better news is that from 6 April, you will be able to invest a total of £10,680 in an ISA, of which no more than £5,340 can be invested in a cash ISA.

So if you can, make the most of these allowances and top up your ISA to the maximum each year. If you would like to know more about stocks and shares ISAs, read The top stocks and shares ISAs for 2011.

3. Only choosing stocks and shares or cash

Some savers believe it’s only possible to invest in a stocks and shares ISA or a cash ISA, but as I’ve just highlighted, you’re perfectly entitled to invest in both if you want to maximise your tax-free savings.

What’s more, you can even choose a different provider for each one. Just make sure you don’t exceed your allowances

4. Not investing early enough

According to recent research from Hargreaves Lansdown, 64% of people surveyed said they were aged 50 or over when they first invested in an ISA and just 5% said they were under the age of 35 when they invested in an ISA.

However, the earlier you start saving in an ISA, the greater your tax-free savings will be. Even if you can’t afford to invest the full allowance each year, it’s still worth investing what you can, however small. Many cash ISAs can be opened with as little as £1, so there’s really no excuse!

What’s more, if you select an easy access cash ISA you will still be able to access your money if you need to penalty-free. You don’t have to lock up your money forever.

Just remember that if you’ve used up your full ISA allowance and you then withdraw money from a cash ISA, you can’t redeposit this money back into the same ISA until the new tax year starts.

5. Failing to shop around for a better interest rate

Once you’ve opened an ISA, you need to keep an eye on the interest rate to ensure it remains competitive. This is particularly important given that many cash ISAs come with a bonus – in fact, according to Moneyfacts, a total of 39 cash ISAs now have an introductory bonus rate.

Usually this bonus lasts for one year – so after this point, the interest rate drops significantly. This means it’s worth making a note of when your bonus rate will expire so that you can then shop around for a better deal once that happens.

Even if you don’t have a bonus on your cash ISA, you should still regularly check the interest rate to ensure you’re getting a good deal. If you can’t find the interest rate on the provider’s website, make sure you give the provider a ring.

Just be warned that not all cash ISAs allow you to transfer funds in from an existing ISA – you can find out which ones do in 15 top cash ISAs for transfers.

And remember, don’t withdraw your funds to reinvest them, otherwise your money will lose its tax-free wrapper. Ask for a transfer form from your new provider instead.

6. Opening an ISA at the end of the tax year

There is absolutely no reason to wait until the end of the tax year to open an ISA. In fact, if you apply for an ISA in the run up to 5 April, this will be the busiest time of the year for lenders, and there is a chance you may not make the deadline in time.

So the earlier you can do this the better. What’s more, if you can afford to use your new ISA allowance when the new tax year starts on 6 April, you can take advantage of a whole extra year of tax-free saving or investing!

*The Santander Loyalty Flexible ISA pays a more competitive rate of 3.50% but you must be a Santander customer to qualify.

More: Get a great ISA | Six easy ways to pay less tax | Earn 7.6% on your savings without going near a bank