When you open an ISA – or individual savings account – you pay your own money into a special tax-free account approved by the Inland Revenue. So strictly speaking, an ISA is a type of account rather than a type of investment. You have to open an account with an ISA manager.

These include banks, building societies, insurance companies, friendly societies, National Savings, some supermarkets, fund management companies, fund supermarkets, financial advisers, stockbrokers and solicitors. Some offer a full range of three mini-ISAs and one maxi-ISA, but many may have just one or two of the options.

You must first decide whether you want to invest in up to three mini-ISAs or one maxi-ISA. If you inadvertently open more ISA accounts than you are entitled to open in one tax year, the later accounts won’t be valid. It won’t make any difference if you first close your earlier ISA. For example, you won’t be able to invest up to £7,000 in a stocks & shares maxi-ISA if you have already started a mini-cash ISA this tax year.

However, you will still be able to invest up to £3,000 in a stocks & shares mini-ISA.

To open an ISA account, you’ll need to give your name, address, date of birth and national insurance number. If you are buying over the phone or online, you’ll also need your debit card details. Many ISAs allow you to make regular monthly contributions, but some are for lump-sum investments only. The ISA manager may set minimum monthly or lump-sum payments.

Buying an insurance ISA

The financial data magazine from MoneyFacts Investment Life & Pensions lists just nine companies offering life insurance ISAs. You invest by monthly payments ranging from £5 to £50 or by lump sums ranging from £250 to £1,000. If you want an insurance ISA, you can contact the company direct.

The small number of insurance ISAs available is testimony to their unpopularity. High charges relative to the small amounts invested can cancel any tax advantages. They are also inflexible. This Cinderella of the ISA family looks doomed, following a government announcement that they could be scrapped in April 2006 – though this won’t affect insurance ISAs taken out before that date. For details of life insurance ISAs, see page 106.

Buying a cash ISA

By contrast, cash ISAs are popular and widely available. It makes sense to put any spare cash into an ISA account to avoid tax – provided you don’t want to invest in a maxi-ISA instead. A copy of the monthly magazine Moneyfacts costs £7.75. This lists all cash ISAs and Tessa-only ISAs. You’ll also find details of cash ISAs on websites such as Money Supermarket and Moneynet.

Some cash ISAs are run through branches, some through the post or by phone, and some through the internet. Branch-based accounts tend to have the lowest rates, post and phone accounts tend to be better and online accounts tend to be the best. The interest rate is the key selection criterion and can vary from a paltry 0.1 per cent to over 4 per cent. But there are other factors to consider.

Are there any bonuses if you limit the number of withdrawals you make – or any penalties on withdrawals?

For example, a handful of ISAs offer fixed rates that tend to be amongst the higher rates but they have hefty penalties if you withdraw during the period of the fixed rate. For best-buy cash ISA rates see page 92 and for terms and conditions see page 93.

Buying a stocks & shares ISA

Before you commit your money to a stockmarket ISA, take heed of the official advice from the Financial Services Authority (FSA):

Buying direct

Perhaps the easiest way to invest in a stocks & shares ISA is to respond to a fund manager’s advertisement. Fund managers are the companies that run collective investment funds such as unit trusts, open-ended investment companies (OEICs) and investment trusts. They decide which stocks and shares to buy.

You can choose an ISA run by a fund manager for its own funds, decide which funds to invest in and can usually switch between funds run by the same fund manager. But you may get a better deal by buying exactly the same ISA through an intermediary such as a discount broker.

Furthermore, there are hundreds of ISAs and investment funds to choose from. The one that leaps out from an ad may not be the best one
for you.

Buying through an intermediary

As with cash ISAs, you can buy a stocks and shares ISA at a high street branch (of a bank, for example), by post, by phone or online.

As a general rule, you may find the cheapest way to buy is online.

Buying through an intermediary can be a better option if it gives a bigger choice of funds from a number of different fund managers – though some intermediaries deal with only one fund manager. An intermediary could be a bank, building society, independent financial adviser, broker, investment manager or stockbroker,

for example.

To track down an independent financial adviser, try IFA Promotion, UK IFA Directory or the Society of Financial Advisers. For an adviser specialising in ethical requirements, try EIRIS – the Ethical Investment Research Service.

For stockbrokers and other investment managers, try the Association of Private Client Investment Managers and Stockbrokers (APCIMS). It is particularly useful for investors who want to use an ISA to make direct investment in stocks and shares. ISAs for direct investment are sometimes called self-select ISAs. They usually carry extra ISA charges that can exceed any tax benefit for most small investors who pay no more than basic-rate tax. By contrast, ISAs set up to invest exclusively in investment funds usually have no extra charge above those that would be levied on the fund if bought outside an ISA account.

Some intermediaries offer advice, but this invariably costs money. Some charge a fee, which may be cost-effective only for large investments. The alternative is for the adviser to receive some of the initial commission. Typically this is 3 per cent. So if you pay £7,000 into the ISA, £210 of that money will go to the adviser.

Other intermediaries don’t give any tailor-made advice to fit your requirements and circumstances but give instead an execution-only or dealing-only service. But while they may not give individual advice, they can give lots of information to enable you choose your own fund or funds.

These intermediaries may be described as a direct service, a discount broker or a fund supermarket. Their key selling point is the option to invest with a range of fund managers at a low price.

The discount comes in a reduction or removal of the initial commission, which can be up to 6 per cent. For example, if you invest £7,000 and get a 5 per cent commission rebate, you would be £350 better off. In addition, check whether the intermediary rather than the fund manager runs the ISA account. If so, it should be easier to switch between funds from different fund managers. Switching can also be cheaper and quicker. Switching an ISA between fund managers can take up to three weeks. Having only one ISA manager simplifies the paperwork and admin and makes it easier to monitor your investments.

The prospect of investing in a range of funds or of switching between funds may seem remote to new or small investors. But the time may come when you want to switch. You may have a poorly performing fund that’s going nowhere or one that’s a had a good run and from which you decide to take your profits. You will then be able to reinvest in a fund that you think has better prospects.

Also, it makes sense to spread your risk and diversify into more than one fund as the value of your investments grows. This is when you might appreciate having an ISA run by an intermediary such as a fund supermarket rather than a fund manager.

For example, FundsNetwork is a fund supermarket that offers over 830 funds from 55 fund managers. Co-funds has over 680 funds from 50 fund managers. Private investors must use this service through an independent financial adviser or other intermediary.

Some intermediaries provide a range of services. Chartwell, for instance, offers an advisory service, has access to a fund supermarket with its own ISA and separately has a discount service for investors who know which fund manager’s ISA they want to buy. It processes your investment application for a £20 fee (or nothing if you apply online) and gives a rebate on the initial commission. Furthermore, it rebates half of the annual commission it receives from the fund manager. A similar range of services is available at Best Invest.