It has been confirmed that the annual ISA (Individual Savings Account) allowance will rise in April 2011 broadly in line with inflation.

The limit is expected to rise from £10,200 to £10,680 of which £5,340 will be available for payment into a Cash ISA.

ISAs were introduced 11 years ago with the aim of encouraging people to save and it is believed that over 20 million people have an ISA.

The increase to the ISA limit may seem small but if fully used over a number of years they money held within it can build into a tidy sum. In fact the Financial Times recently reported that a number of investors have in excess of £1m in their ISA portfolio. Whilst such large holdings may not be the norm, most of us have less than £100,000 in our ISAs, we should not dismiss the humble ISA just because the limits are low compared to other alternatives.

Most of us know the principle reason to invest in an ISA; when you come to take money out, whether as an income or a lump sum, the money you withdraw is tax free. However, with the rise in the ISA allowance just a few months away we thought we would take a look at some practical reasons why you might invest in an ISA:

1. If you are a more cautious investor and like to hold money in deposit based investments an ISA can be a great way of sheltering your interest from tax. The interest rate you get will already be pretty low compared to historical cash returns, therefore holding it in a Cash ISA will mean you get to keep more of it than a normal deposit account which is taxed at your highest marginal rate.

2. ISAs are often used as an alternative to a pension when trying to create an income for retirement. A pension attracts immediate tax relief but the income in retirement is subject to tax, only 25% of the fund can be taken as a lump sum and you have to be over the age of 55 to take any benefits from the pension.

Whilst the tax relief usually helps to overcome the perceived disadvantages of a pension, an ISA can still play an important role in retirement planning.

We all have a Personal Allowance, which is the amount we can earn before tax starts to be paid, in the 2010/11 tax year a 65 can earn £9,490 a year without a liability to income tax. Income above the Personal Allowance, if it comes say from a pension is taxed, firstly at 20% moving on to 40% and 50%. Income from an ISA is tax free, therefore introducing it into a portfolio and splitting investments between a pension and ISA tax wrapper can hold significant tax advantages in retirement. Carefully planning between an ISA and Pension can help to create an extremely tax efficient source of income.

3. Using an ISA in conjunction with a Pension can also provide advantages when considering tax relief. An individual whose salary is subject to regular and significant upward reviews may prefer to invest into an ISA whilst they are a basic rate tax payer and then move the money accumulated in the ISA into a Pension when they become a higher rate tax payer, thereby qualifying for a higher rate of tax relief. This sort of arrangement is not unusual, however the new pension funding rules make it more complex and advice should be taken to ensure that such a process is beneficial.

4. ISAs can hold shares in single companies, a fact sometimes overlooked by investors who often mistakenly believe that only Cash and Collectives (also known as funds) can be held in them.

5. With the rise in tuition fees going to University will become even more expensive and many parents want to help their children with the cost. Saving via an ISA can be an ideal way to produce a fund to help meet the costs of higher education or even the deposit on that first home.

ISAs have certain advantages making them ideal for this job. Investments can be made in Cash or Equities (generally via funds, although not always) which means needs with different timescales and risk tolerances can be catered for. Furthermore ISAs can accept lump sums and regular contributions, which can altered to cope with a variety of funding patterns and the investments held can be planned bearing in mind the likely timescale for when they will be needed.

As you can see, there are many reasons not to overlook the humble ISA when planning your investments. The maximum you can pay in may be seen by many as low, but funded annually your holdings will soon build up and with tax efficient investments disappearing fast, think Child Trust Funds NS&I Index Linked Certificates, it is one of the few remaining investments with tax advantages,