Many happy returns ISA

ISAs have just celebrated their first birthday and congratulations should be in order. While stocks and shares ISAs gained most of the publicity, cash ISAs have proved a quiet success. By December 1999, they had attracted ?8.6 billion.

ISAs have just celebrated their first birthday and congratulations should be in order. While stocks and shares ISAs gained most of the publicity, cash ISAs have proved a quiet success. By December 1999, they had attracted ?8.6 billion.

Cash ISAs offer the safety and security of a building society deposit account, but allow you to take the interest free of income tax. They are provided by banks, building societies and National Savings and are most suitable for cautious investors.

But falling foul of ISA rules is easy. A mistake made last year by many investors - thought to be more than 50,000 - was to open a mini-cash ISA account only to discover that this slashed the amount they could invest in stocks and shares. "As soon as you put even ?1 in a mini-cash ISA you cut the amount you can invest in stocks and shares from ?7,000 to ?3,000," says Justin Modray, investment adviser with Chase de Vere.

There are two types of ISA. Mini ISAs allow you to invest up to ?3,000 each year in stocks and shares, up to ?3,000 in cash and up to ?1,000 in life insurance in any tax year. You can buy each component from a different ISA manager. Maxi ISAs allow you to invest your full ?7,000 annual allowance in stocks and shares. Alternatively you can invest up to ?3,000 in shares, up to ?3,000 in cash and ?1,000 in insurance. All must be bought from the same manager. You cannot buy a mini ISA and maxi ISA in the same tax year.

Many savers wrongly think you have to tie your money up in a cash ISA for a set period, says Bhavesh Amlani, director of Simple Savings. "With most accounts you can withdraw it whenever you want. Any cash kept in a deposit account should therefore be kept in an ISA," he says.

However, while you can withdraw as much as you like with many cash ISAs, you cannot put in more than ?3,000 each tax year. You should also watch for long notice periods and penalties for early withdrawal and keep an eye on rates, because they may not always stay high.

Coventry building society currently pays 7.75 per cent for its Privilege mini-cash instant access ISA, which is for existing members only. Alliance & Leicester pays 7 per cent on balances of ?3,000, C & G also pays 7 per cent, but on a minimum balance of ?1,000. Barclays Bank pays 5.75 per cent on balances of ?500, but 6.75 per cent if you invest ?3,000 and recently-launched internet bank Smile, currently trying to attract new customers, pays 7.25 per cent on balances as low as ?1.

Anyone unsure which cash ISA to chose could go for one that meets the Government-set CAT standard, which ensures no charges, a minimum transaction size of ?10, withdrawals within seven working days, and interest no lower than 2 per cent below base rate. But this does not guarantee the most attractive interest rate. The Portman building society pays 7.3 per cent but fails the CAT test, while the NatWest CAT-standard cash ISA pays 6 per cent.

Not everybody is in favour of cash ISAs. Alan Beestin, director of The ISA Shop, says the tax benefits can be over-rated. Interest of 7 per cent on ?3,000 would earn ?210 year. A basic rate taxpayer would pay 20 per cent of this to the Inland Revenue - just ?42. "The real benefits ISAs bring are in avoiding capital gains tax on equity investments. Over the longer term, stocks and shares ISAs will bring much greater returns, and therefore much greater tax benefits, than cash ISAs."