An Individual Savings Account is a method of saving tax free. You can either keep your savings as cash, in a life assurance policy – such as an endowment – or as an investment in the stock market.

The maximum amount that you can invest in one full year is £7000 per person although there is no limit on the number of years that this can be held in the account.

You make one monthly payment which goes towards your interest payment and into an ISA savings vehicle. Your monthly payment will be calculated using an assumed growth rate and the amount should accumulate with any growth being regularly added.

There are various different methods of using an ISA for capital repayment. Some plans do not have a fixed term and you use the money to pay off your mortgage as soon as the value has accumulated. If your investment has performed well, you may be able to pay off the balance well ahead of the planned term.

You can roll up your monthly payments into one annual payment. Depositing this at the beginning of the year means that there is more money to invest at the start of the year, so the plan should grow faster.

Life cover is not a condition of the policy, so does not have to be bought. This means that if you need life cover, you have to arrange it separately.

The ISAs available:

Maxi ISA

This type has an annual limit of £7,000 per person with no limit to the amount that can accumulate. This can be held in cash, stocks and shares or life insurance although annual limits do apply to the different components. You can hold £3,000 in cash and £1,000 in life insurance with the remaining £3,000 in stocks and shares.

Mini ISA

You can hold one Mini ISA for each component part of a Maxi ISA. For instance you can hold one in cash, one in stocks and shares and one in life cover. The maximum values that you can hold in each component are set as for a Maxi ISA. The benefit of separate ISAs is that each can be held by different specialists rather than just one company.

The different components:

Cash

Cash ISAs are available from banks, building societies or the post office. It can be a simple tax-free savings account or a money market unit trust. This pools the money from investors and spreads it across different deposits on the wholesale money markets.

Life Insurance

Life ISAs are single premium contracts that can accept a lump sum deposit. The deposit is invested in a life insurance linked investment product.

Stocks and shares

This is the most popular ISA investment and is suitable for medium to long term investors who want a higher tax free income and for their capital to grow. You can invest in any number of different shares or into a managed fund in any stock market in the world.

It used to be possible to buy an ISA mortgage package, but the market volatility made these products higher risk, so many were withdrawn. This means that you are responsible for any ISA products that you buy and should therefore only be undertaken under the strictest of guidelines and advice.

Advantages

If you were to pay the same amount of money into an ISA as an endowment policy, the ISA should yield higher returns. This is because you are not paying your entire premium towards a life insurance policy and your gains are added to the fund tax free. Also less money is being paid towards set up and maintenance charges or towards commission.

If you have a cautious attitude towards risk, you could choose a less risky method of ISA investment, for instance cash. The growth will be far less, but there will be no risk involved.

ISAs are more flexible than endowment policies and the length of the term can be more variable. If you receive a cash lump sum, like a bonus, you can deposit this immediately and gain from the extra growth instantly, provided you do not exceed your annual limit.

Disadvantages

The higher your loan is, the more problems the annual £7000 limit will cause. It is possible to invest more, but you will be taxed on anything above the limit.

If you are a high earner, you may not want to use up your ISA allowance with a mortgage linked product.

Although a couple can invest £14000, these funds can not be held together so funds will accumulate separately and at a slower rate than if they were held together.

The government will only guarantee that ISAs will exist until April 2009. If they cease to exist at this date, you will have to find an alternative scheme to place your investment.

If you are relying on the stock market, your fund will have to grow at a rate which is assumed at the beginning of the investment, otherwise you will have a shortfall when you pay back your capital loan.

Investments can be risky – particularly those which are equity linked. These will be highly affected by any market fluctuations. It is possible to invest in more predictable investment bonds.