The UK government introduced ISAs, which stand for Individual Savings Accounts, in April 1999, to replace the existing PEP (Personal Equity Plan) and TESSA (Tax Exempt Special Savings Account) investment schemes. The ISA is a tax-free savings scheme to encourage people to save for the short- and long-term.
There are three general types of ISA account to choose from, which are called ‘components’: cash savings, stocks and shares and life insurance policies. The life insurance ISA is aimed at people who do not want the volatility or the risk associated with investing in stocks and shares for the long-term.
Initially the life insurance ISA contribution limit was set at £1,000 a year; however, this has been increased to match the general ISA scheme of £7,000 a year until April 2006 and then £5,000 a year until April 2007. However, unlike the cash savings and stocks and shares ISAs, the life insurance ISAs have not been very popular, particularly due to the low contribution limit.
Although the life insurance ISA has less volatility than investing in the stocks and shares ISA option, you are still exposed to the markets and thus your investment can go up or down. However, the with-profits aspect of the scheme will help smooth the volatility of the markets somewhat.
Like ordinary life insurance policies, there are two types of schemes for the life insurance ISAs: unit-linked or with profits. The unit-linked policies buy a range of stocks or shares offering returns linked directly to the value of the units. The second option, with profits, also invests in a range of stocks and shares, but the returns are somewhat smoothed out over time, with some of the return from the good years held in reserve, to ease the losses in poor years. This aspect helps to smooth out the volatility of the stock markets.
The advantage of choosing a life insurance ISA is that it does combine the advantages of a cash savings ISA, with those of a stocks and shares ISA. It offers greater growth prospects than the simple cash savings ISA, but is lower risk than the stocks and shares investment option. Also, in the event of your death, the life insurance ISA will also pay out as per a regular insurance policy.