Protect your savings from tax

Nobody likes paying more tax than they have to. However, if you're saving or investing without making use of your individual savings account allowance, that's exactly what you're doing.

The thinking behind ISAs is simple. An ISA enables you to shelter £7,000 worth of investments from the tax man each year. You can save up to £3,000 in a cash ISA, or up to £7,000 in an equities ISA, which can hold a wide range of investments such as bonds, funds and even direct shareholdings. You can take out both types of ISA, but your total savings must not exceed £7,000.

There are significant tax advantages to taking out an ISA instead of just putting your cash into a standard savings account or investing outside an ISA. This is because both income and gains are allowed to build up tax-free within your ISA.

So if you've not taken advantage of this year's allowance it pays to do so by 5 April - the last day of the tax year.

Cash ISAs

The most popular option is the cash ISA. Simple and easy to understand, this is a tax-free savings account, which is useful for short-term savings.

However, if you already have enough cash for emergencies - experts recommend three to six months' salary - and your savings objectives are long-term, it's worth considering an equity ISA.

Remember that shares and investment funds can fall in value as well as rise, but if you're going to invest on the stockmarket you need to take a long-term view and not to get side-tracked by short-term fluctuations.

Equity ISAs

When choosing an equity ISA there's a multitude of options. What suits you will depend on your attitude to risk and your investment objectives.

Corporate bonds and gilts come at the lowest end of the risk spectrum. These are IOUs issued by companies (bonds) or by the government (gilts). The issuers promise to pay you a fixed-rate interest for the money you've lent them, and to return the money you've invested at the end of a fixed term. Bonds and gilts trade on the London Stock Exchange, so the price you pay is determined by the market forces of supply and demand and is not necessarily the same as the amount you would receive back if you held them to term.

Corporate bonds receive a risk-rating ranging from AAA to junk bonds, depending on the financial stability of the company issuing it - the safer the company the lower the rates they pay.

In the same way that you can invest in shares via a pooled investment fund, you can also invest in pooled funds of corporate bonds and gilts. These are typically lower-risk than funds which invest in shares, because the returns you receive from them are easier to determine in advance. But for this same reason, the returns you can expect will also be lower.

However, if you step up the risk a gear and invest in equities you can obtain much greater growth. You can invest in equities in several different forms. You can either buy shares via a stockbroker, using what is known as a self-select ISA (so long as the shares are listed on the LSE), or you can invest in a pooled investment fund run by a fund manager, such as a unit trust, an open-ended investment company (OEIC), or an investment trust.

From a risk point of view, a pooled fund is usually the best option for most investors - by investing in one fund you can get exposure to 50 or more companies and can benefit from the fund manager's expertise.

Unit trusts or OEICs are the most popular option. These are open-ended funds, with new 'units' becoming available for sale as and when investors need them. Investment trusts, on the other hand, have a limited number of shares (they are closed-ended). They are listed on the LSE, so the price fluctuates according to demand.

Investment trusts are overseen by a board of directors, which selects a fund manager to manage the investments, and have the ability to borrow money to invest further. So they're sometimes considered to be riskier than other forms of investment funds.

Unit trusts usually levy an initial fee, between 3.5% and 5.5%, and an annual management fee, 1% or 1.5%. Investment trusts usually do not levy an initial fee and have only minimal annual fees.

Many fund managers operate ISA savings schemes, which allow investors to pay money into their ISAs monthly. Some accept contributions of as little as £20 a month, although most start at £50 a month. Alternatively, all fund managers will accept lump sums.

When it comes to choosing a fund, the investment world is your oyster. Following a change in legislation at the end of 2005, you aren't just confined to bonds and equities, you can also hold commercial property funds in your ISA.

Funds that buy bricks and mortar directly can be a useful diversifier as they don't follow stockmarket movements. Alternatively, you can opt for real estate investment trusts (REITs), which allow you to buy shares in property companies. They have a slightly greater potential for growth, but because they are shares, their performance is correlated to the stockmarket - so they aren't such a good diversifier.

If you're new to investing it's best to go for a lower-risk option and steer clear of smaller company or emerging market funds.

You can buy equity ISAs direct from fund managers, but you may be limited to their range of funds. Discount brokers can be a good bet as they offer good discounts on charges. However, for active investors wanting to build up and manage their portfolio online, a fund supermarket - such as those offered by Interactive Investor - are often a better option.

While discount brokers and fund supermarkets can't offer advice, many do offer online tools to help you find the right options for you. If you don't understand the options it's always worth seeking the advice of an IFA - you can find a local one through IFA Promotion. Visit their website (unbiased.co.uk) or phone 0800 085 3250.

The new ISA rules

In December's pre-Budget report, Chancellor Gordon Brown confirmed changes to ISA rules and pledged to maintain the £7,000 ISA savings limit beyond 2010.

There will no longer be a distinction between mini and maxi ISAs. Now savers simply have to choose between a cash or an equity ISA.

It will now be possible to transfer any funds you have accumulated in cash ISAs into equity ISAs without losing any of the tax advantages or affecting your allowance for the year.

Holders of PEPs will also be able to transfer their fund into an ISA, as will holders of child trust funds, when they turn 18.