Individual Savings Accounts

Savers, wake-up to the Isa's complexities

The UK savings system enters a new era on 6 April with the advent of the individual savings account (Isa), but BBC News Online warns that savers jumping in without fully understanding their options may be caught short.

While the replacement of Peps and Tessas with the Isa is an attempt to bring tax-free savings options under one umbrella, the multi-faceted nature of the new account threatens to be a more confusing system for the average saver, at least in the short term.

Don't rush in

There is no need to rush into the Isa market in April. Just as with Peps and Tessas previously, consumers have the whole financial year in which to take advantage of their annual allowance. Of course, those with cash to invest now would be wise to put it to work sooner rather than later to make the most of tax-free returns.

"We would strongly advise savers to shop around in April to make sure they are getting the best deal," said Justin Modray, financial adviser with Chase de Vere.

He and other financial advisers are warning that those jumping in may well find themselves unable to make the most of the shares allowance in the first year.

To understand the pitfalls, savers must understand how the different Isa offerings work.

There are three types of Isa:

• The mini account, which can hold either cash, shares or life insurance investments
• The maxi account, which can hold a mix of all three.
• The Tessa Isa, exclusively for the proceeds of a maturing Tessa

For maxi and mini options, in the first year there is a limit of £7,000 which can be invested. This maximum allowance can be used up with three mini Isas or one maxi. In future years, the overall allowance will be £5,000 with the cash allowance falling to £1,000.

Take a close look at Isa options

At first glance, the mini option offers more flexibility, allowing savers to choose a specialist provider for each component, for example, a bank or building society for cash, an insurance company for the life component and a fund manager for the shares.

A maxi Isa will see one provider manage all three components.

The mini trap

But here's the trap. In this first year, savers opting for mini Isas are limited to investing a maximum of:

• £3,000 in cash
• £3,000 in shares or share funds
• £1,000 in life insurance

However, investors taking up the maxi option can devote their whole £7,000 allowance for the first year to shares or share funds.

Those opening a cash mini Isa automatically rule themselves out of the maxi option, and so will find themselves limited to investing £3,000 in shares for the first year. Advisers say most savers are not aware of this restriction.

Pre-launch blitz

The marketing blitz in recent months tempting savers with "pre-Isa" accounts is not helping matters. These accounts do not have tax-free status like Peps, Tessas and Isas and are an attempt to commit savers to the same provider when real Isas become available.

"If customers open a pre-Isa account, this money could be rolled over into a cash mini Isa and they could lose out on share investments," Mr Modray warned.