How to find an ISA that suits all your needs

James Daley is your guide to the complex world of the individual savings account

With just 10 days to go until the end of the tax year, time is running out to use your 2004/5 individual savings account (ISA) allowance. Come 6 April, those who have not taken advantage of either their mini or maxi allowances will lose out on another year of tax-free saving - a concept that, even after the confirmed extension in last week's Budget, is only certain to be around for another five years.

With just 10 days to go until the end of the tax year, time is running out to use your 2004/5 individual savings account (ISA) allowance. Come 6 April, those who have not taken advantage of either their mini or maxi allowances will lose out on another year of tax-free saving - a concept that, even after the confirmed extension in last week's Budget, is only certain to be around for another five years.

For those who are planning only to invest their savings in cash, mini ISAs are still a no-brainer. If you put your money into a regular non-ISA savings account, the Inland Revenue will automatically take at least 20 per cent of any interest.

In a mini cash ISA, however, you receive all the interest tax-free. And while £3,000 is not a huge annual allowance (and has not been increased since it was set seven years ago), those who have used their full allowance each year since 1998, would now be about £1,000 better off than someone who had saved the same outside an ISA. Most cash ISAs also come with the benefit that you can get your hands on your money whenever you need it - although the best rates are often only available to those who are willing to carry out transactions on line or over the telephone, as opposed to using a bank or building society branch.

One other factor to watch out for is whether interest is paid monthly or annually. If you are looking to draw a regular income from your cash ISAs, you will want to ensure you invest in a plan that pays monthly interest, although this could prevent you getting the best rate on the market. The majority pay interest annually.

For those who are looking to invest in stocks and shares, the advantages of using an ISA are not so clear cut. Since Gordon Brown scrapped the tax credit on dividends last year, people who pay the basic rate of income tax (anyone earning less than approximately £37,000 a year) are unlikely to find themselves much better off by investing in an ISA - unless they are using their full allowance each year.

Before the rules were changed last April, basic-rate taxpayers would be refunded the 10 per cent that they would normally be taxed on dividends (from UK companies), while higher-rate taxpayers would be refunded the full 32.5 per cent that they are liable to pay.

Under the new rules, however, basic-rate taxpayers are still charged the 10 per cent tax on dividends - whether their investment is held inside of an ISA or not.

For higher-rate taxpayers, however, there are still some compelling advantages to investing within an ISA. While these investors will still be charged 10 per cent tax on dividends, the extra 22.5 percentage points of tax that would be due are waived within an ISA.

Both basic-rate and higher-rate taxpayers also benefit from the exemption in capital gains tax (CGT). However, given that every UK citizen has more than £8,500 of CGT allowance every year, most smaller investors are unlikely to ever come close to realising a taxable CGT liability unless they have been putting £7,000 into their ISA every year for several years.

But Robert Walters, an investment director for BDO Stoy Hayward, says that investors are still almost always going to be better off investing in an ISA from an administrative point of view, as these savings do not have to be declared to the Inland Revenue.

Walter also says ISAs are not always perfect for higher-rate taxpayers, in spite of the tax treatment of dividends. Investments that diminish in value while held outside an ISA, can be offset against any future gains for tax purposes. However, the same is not true for investments held within an ISA account. "For higher-rate taxpayers investing over the long-term, this is something that is worth thinking about," he says. "But as with all these things, it is about getting the balance right."

If you're taking out a maxi ISA, remember that you can't also take out a mini ISA in the same tax year. If you're a smaller investor and you don't have any cash saved at all, it probably makes sense to start off by taking out a mini cash ISA.

Until 6 April, you are allowed to take out three mini ISAs in any tax year - one cash, one stocks and shares, and one life insurance. The limits for these are £3,000, £3,000 and £1,000 respectively. From 6 April, however, life insurance ISAs are to be scrapped. Investors will then only be allowed to take out two mini ISAs each year - one cash (still only up to £3,000) and one stocks and shares ISA (up to £4,000).

The most tax-efficient way to invest in stocks and shares outside an ISA, is in your pension. But you won't be able to get your hands on this money until you're at least 55, so this isn't a suitable option if you're saving for the medium or the short term.

Once you've decided which type of ISA you want to go for, the next step is to track down the best savings account or investment to go inside it. Finding the best cash ISA is fairly straightforward. Websites such as www.moneyfacts.co.uk, and www.moneysupermarket.co.uk have best-buy tables and free search facilities. Alternatively, you can find limited savings account best-buy tables on pages 13 and 15.

If you decide to go ahead and opt for a stocks and shares ISA, deciding where to put your money is less simple. Most traditional investments, such as UK-listed individual shares and unit trusts, qualify for inclusion within a maxi ISA. However, there are some exemptions.

Many offshore collective investment funds, such as hedge funds, do not qualify, while most funds that invest directly in property are also currently ineligible. But new rules, due to be introduced next year, will allow investors to hold a wide range of property investment funds in their ISAs.

If you are unsure about making your own decision as to where to invest, you should seek professional advice. To find an independent financial adviser in your local area, visit IFA Promotion's website at www.unbiased.co.uk.

If you prefer to select your investments yourself, and you are new to stockmarket investing, then it is wise to start off with a generalist equity or bond fund, depending on your attitude to risk.

We asked a panel of three financial advisers to select their best fund choices for investors with a high, medium or cautious attitude to risk. When considering their recommendations, you need to be aware that the higher-risk funds offer potentially much greater losses if the market turns against you, although they also offer potentially much higher returns.

Andrew Merricks, the head of investment for Skerritt Consultants, the Brighton-based financial advisers, says he advises cautious investors to opt for Investec's Managed Distribution fund, which invests in a mix of equities and bonds While he admits that, typically, lower-risk investors would put their money into pure bonds, he believes the outlook for the bond market over the short to medium term is bleak.

"I'm a little bit worried about the prospects for bonds at the moment, but this fund allows the fund manager to invest up to 60 per cent in equities too," he says.

Paul Ilott, from Bates Investments, the Leeds-based financial adviser, says he would point cautious investors towards Jupiter's Merlin Income Fund - a fund of funds that invests in a selection of fixed-interest and equity funds.

"Given the current outlook for equities is better than bonds, it's difficult for cautious investors to select a single fund with reasonable growth prospects that doesn't include at least some exposure to equities," he says.

Justin Modray, an investment adviser for Best Invest, a London-based financial adviser, says that he would advise lower-risk investors to put their money into the New Star High Yield Bond fund. Like the Investec and Jupiter funds, this has exposure to "investment grade" corporate bonds (which are issued by companies with strong credit ratings), but also invests in high-yield bonds, which tend to perform more in line with equities.

"Corporate bonds tend to be safer than equities, but high-yield bonds do tend to have some correlation with stockmarkets," he says. "This means that if stockmarkets rise over time, this fund will, to an extent, benefit. Obviously, the reverse is true, which is why the safety net of investment-grade bonds is attractive."

For those looking for something with a slightly higher-risk element, Merricks recommends the Schroder UK Alpha fund, which focuses on investing in large UK companies. "This fund has 75 per cent invested in large cap stocks, which tempers the risk, and Richard Buxton is a very good fund manager," he says.

Ilott plumps for the Merrill Lynch UK Equity fund, which invests three-quarters of its assets in larger UK companies.

Modray recommends investing across a combination of the Artemis Global Growth, Framlington UK Opportunities and New Star High Yield Bond fund. The Artemis fund invests in the major equity markets outside the UK, while the Framlington fund, run by one of Britain's best performing managers, Nigel Thomas, invests in a small portfolio of UK stocks.

For those people who are willing to take a much greater risk with their capital, Modray advises combining the Framlington fund with the Aberdeen Far East Emerging Economies and the JPMF Natural Resources funds.

The Aberdeen fund is "a good route to access the exciting emerging economies of the Far East, including China and India," he says. "The manager, Hugh Young, has vast experience in these markets and manages to keep risk at a reasonable level given the high-risk nature of these markets."

The JPMF fund invests in commodities, which have a very low correlation to most other asset classes and provide good diversification for a more seasoned investor's portfolio.

Ilott also chooses the Framlington UK Select Opps fund, while Merricks recommends New Star's Hidden Value fund. This fund invests across a concentrated selection of UK equities and is overweight in smaller companies.

'It's quick and easy online'

Stephanie Morgan, a facilities manager from Leeds, is building up her savings again this year, after laying out for a new house.

Having invested the full £3,000 annual mini ISA allowance in First Direct's e-ISA, she is already planning to invest the same again next year, before beginning to look at investing in the stock market.

"Anyone who works full-time like me gets fed up being taxed, so it's nice to at least be able to avoid tax on your savings."

First Direct's e-ISA - which is paying annual equivalent interest of 6.25 per cent until the start of October, after which the rate falls to 4.35 per cent - is only available over the internet.

Morgan prefers the speed and ease of web-based banking, however. "Over the telephone, it always takes so long - with all the security checks. Online, it's quick and easy."

'I want to cut my tax bill'

Jonathan Edwards, a finance manager for a construction company in London, has been investing in Isas and Peps for 10 years. Recently, he started investing in Norwich Union's UK index-tracking fund every month.

Having sold his house, and switched to renting, he plans to take out another Isa as soon as the tax year begins, to try to protect as much of his capital from tax as possible. "I sold my house a year ago, so I'm trying to keep it in tax-free investments, rather than have it sitting in the bank and paying tax," he says.

Although he has spent a small amount of his savings on new computer equipment, the main aim for his Isa is to build up a retirement fund. He keeps an eye on the business pages, but concedes that his decision to go with Norwich Union's index fund was not too scientific: "I signed up after seeing a promotion in Tesco."

'I was taught to invest'

Pam Patterson, a nurse from London, saves £30 a month in a Scottish Friendly Isa. Encouraged by her parents, who have always been savers, Pam also has a child bond for her son, Dillon, seven, and a Scottish Friendly Scottish Bond for herself, which will pay a lump sum in 10 years.

"My parents taught me the importance of investing and encouraged me to save. They always said saving something is better than saving nothing, as you never know what the future might hold."

Pam opted for the regular-saver Isa as it seemed a "very affordable way to save", and she had been happy with Scottish Friendly's performance across her other investments. "I don't even notice the money going out of my account, yet in five or 10 years' time I'll have a nice investment."

FACT FILE: ISAs IN A NUTSHELL

* You can only take out one maxi Isa in any one tax year, or three mini Isas (one cash, one stocks and shares, and one life insurance). You cannot have both a maxi and mini Isa in the same tax year.

* The life insurance Isa is being scrapped on 6 April, after which you will only be able to take out one mini stocks and shares and one mini cash Isa - or one maxi Isa - in any given tax year.

* You must be 18 to invest in a stocks and shares or life insurance ISA. But you can open a cash Isa once you are 16.

* Maximum allowances:

Until 6 April, the limits are £3,000 in cash, £3,000 in stocks and shares, and £1,000 in life insurance.

After 6 April, £3,000 per tax year in cash; £4,000 in stocks and shares.

Maxi Isa: £7,000 per tax year (no more than £3,000 in cash).

These limits apply only until April 2010, when they will come under review.

* Most regulated investment funds qualify for inclusion within a stocks and shares Isa.

* Most property funds are currently ineligible for inclusion within a stocks and shares Isa. But proposed new rules will allow property funds to be included from April 2006.