Guide to investment ISAs: Save tax - buy your ISA now

The doom and gloom merchants are beginning to change their tune.

Investors wanting a tax-efficient way to put their cash into the stock market have stopped grieving the loss of the beloved PEP. In October, for the first time, sales of investment fund-based Individual Savings Accounts, ISAs, surpassed sales of PEPs for the similar period last year.

Undoubtedly there are grounds for bemoaning the Gordon Brownian complexity of the ISA set-up, but a simple fact remains - an ISA will cut your tax bill while you save for the future of you and your family.

This is why the doom and gloom mongers are beginning to change their tune. There is increasing confidence that millions of regular investors in the old PEPs who have so far failed to start an equivalent ISA will not give up the stocks and shares habit.

Jason Hollands, of advisers Best Investment, says investors should get in early to beat the crush at the end of the tax year. "Questionable advertising and the urgency of beating the deadline are all likely to cloud your judgement and large seasonal flows of money into the market can distort prices," he says.

"In fact, our research shows it is usually best to invest in the three months to the end of December, when six-month returns have on average been twice as good as those made towards the end of the tax year. Sending a form in at the very last moment also runs the risk of missing the deadline altogether and losing your annual allowance forever."

An equity ISA may not be appropriate for you. First, you need to be sure you haven't already bought another type of ISA. In this financial year you are allowed only one equity mini-ISA with up to pounds 3,000 invested, which you could combine with cash and insurance mini-ISAs, or a single maxi- ISA with a pounds 7,000 limit. It is becoming clear that some people have mistakenly been able to buy both a mini- and a maxi-ISA, leaving an almighty mess to be sorted out by the taxman at the end of the year.

The other fundamental question is, when you will need to get your hands back on the money. The volatility of stock markets make shares too risky as a short-term investment, and you should be planning on holding the ISA for at least three years. If not, go for a simple cash ISA, which is basically a tax-free bank account.

Financial advisers will be able to guide you to an investment ISA that provides the right mix of share-based and bond-based funds, depending on what you want it to do. If you want an income from your ISA bonds are best, but if you want to let it grow over the longer term equity funds are likely to be the best bet.

Gordon Maw at Virgin Direct says an ISA might be a useful way of saving to top up your retirement income. "The three important factors to consider when you plan your retirement are your current tax rate, the age you plan to retire at and your own attitude to saving," he says. "Higher rate taxpayers should need no invitation to take advantage of the tax benefits of personal pensions. For basic rate taxpayers pensions still have the edge unless you intend to retire very young."

Since annuity rates tend to be less generous the younger you retire, an ISA could actually produce a comparable level of income for someone planning to quit the rat-race at, say, 50. An ISA would also be a sensible alternative for those who are unable or unwilling to commit funds to a personal pension.

"Some people prefer the discipline of locking savings away in a pension and others need to know they will be able to get their hands on their money," says Mr Maw.

Most advisers will steer you away from placing too much emphasis on whether an ISA has the Government seal of approval, the CAT standard. While the CAT mark guarantees a "fair and reasonable deal" on accessibility and charges - which cannot exceed 1 per cent a year - it does not mean an ISA will suit your needs or will necessarily perform well. It also effectively disqualifies most actively managed funds, which cost more because they aim to outperform rather than track share prices and which may have more than the permitted 50 per cent exposure to US and other non-European stocks. It also rules out flexible ISAs which allow you to pick at least some of the investments among which your cash is shared.

Champions of the CAT standard say there is little conclusive evidence that actively managed funds outperform cheaper, simpler trackers over the long run, so the portion shaved off in fees can make all the difference to the value of your investment.

In the table above, The Research Department ranks the cheapest maxi- ISAs - those which invest in tracker funds and those using the more common actively-managed funds - by taking into account all the types of possible charges.

The organisation says investors must pay attention to more than simply the headline initial charge; the annual management charge, plus exit and dealing costs and the fees for transferring money in or out of the ISA could all add up.

As long as there are practically as many charging structures as there are ISAs, it is best to let an independent financial adviser guide you through the maze. IFAs are increasingly able to offer discounted deals you may not find elsewhere.