What are Innovative Finance ISAs?
Innovative Finance ISAs allow peer-to-peer investors to shelter their returns from tax. Read on for everything you need to know about Innovative Finance ISAs.
Innovative Finance ISAs are a type of individual savings account that allows investors who lend to people via peer-to-peer platforms to shelter their returns from tax.
Peer-to-peer lending has had its share of negative headlines in the last couple of years, and the IFISA has seen its popularity wane. Yet while the number of subscriptions into IFISAs in 2018-19 fell by 22% from the previous tax year, the average amount paid in jumped by more than half to £8,632, suggesting these products are still popular among wealthier investors.
So how do IFISAs work, and are they worth the risk?
How peer-to-peer lending works
Peer-to-peer (P2P) lending connects lenders and borrowers directly through a peer-to-peer investing platform. This allows individuals and small businesses to borrow money directly from private lenders instead of going down more traditional routes, such as taking out a bank loan.
Different P2P platforms specialise in different areas – some lend to small businesses, some to individuals, some invest in property, and some focus on impact investing or social enterprise projects.
Pros an cons of IFISAs
You can start investing with as little as £1, and you can transfer money in from other ISAs.
Investing within the ISA wrapper means you have the advantage of never having to pay tax on any money you make from P2P lending, and you can put in up to £20,000 each tax year.
You could potentially get attractive returns.
That said ...
IFISAs are higher risk than other types of ISA. There are no guarantees you will get the predicted returns, and you could end up with less money than you put in if the individuals or businesses you lend to struggle with their loan repayments.
More than one P2P platform has collapsed in the last couple of years. The Financial Conduct Authority (FCA), a financial watchdog, recently clamped down on the sector so that, now, inexperienced investors who have not taken regulated financial advice can only put a maximum of 10% of their investable assets into P2P. Platforms also have to evaluate would-be investors to check they understand the risks.
As personal and small business insolvencies have risen due to COVID-19, a wave of defaults is expected on P2P platforms as people and businesses struggle to repay their loans. Many platforms have already revised down their returns predictions and tightened their lending criteria.
Also, P2P ISAs are not covered by the Financial Services Compensation Scheme. P2P platforms have their own safety nets to protect investors from bad debts. Most will have some sort of provision fund to compensate investors when loans cannot be repaid, but these facilities may not be able to cope in the face of a large number of defaults.
How to compare and choose an IFISA
Before you invest, it’s essential you understand where your money is going and what protection is in place if any borrowers default on their loans.
If the Innovative Finance ISA doesn’t feel right for you, there are alternatives. A stocks and shares ISA lets you invest in the stock market and grow your money.
With a cash ISA or a stocks and shares ISA, you are also covered by the Financial Services Compensation Scheme against a provider collapse for up to £85,000 (so long as you choose a regulated fund provider). Note: This doesn’t mean you are covered if your investments underperform – that’s just the risk you take when investing.
How do I set up an IFISA?
After doing your research, you open an IFISA through the provider's website and deposit money.
The platform lends your money out, usually to multiple borrowers in small chunks to spread your risk. You're generally able to choose what sort of borrower you lend to – high-creditworthy borrowers are less likely to default on their loans, so you will get a lower interest rate if you choose to lend only to them. Some specialist platforms will let you choose specific businesses or projects you want to invest in. The platforms vet prospective borrowers, assess their creditworthiness, and chase late payments.
» MORE: Investment platforms explained
You get monthly repayments as well as interest, which you can choose to withdraw or reinvest automatically into new loans. Your platform will deduct its fee from your returns.
If you want to withdraw your money, the platform will need to sell your loans to other investors. This means you may not get your money straight away and there could be a delay if a buyer can’t be found.
You can pay into only one IFISA each tax year, but you can split your ISA allowance (which is £20,000 in the 2020/21 tax year) across one of each type of ISA including the IFISA. You can transfer money from another ISA into multiple IFISAs.
How can I get an IFISA?
If you’re over 18, you can open one directly with a P2P platform via its website.
The IFISA had a bit of a slow start at launch, with few providers offering it at first due to regulatory delays, but now there are more options to choose from.
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in
Hannah is an award-winning journalist with a background in the trade press. She writes about finance, asset management and business for Shares, Citywire, FE Trustnet, and interactive investor. Read more