What are Innovative Finance ISAs?
Innovative Finance ISAs allow peer-to-peer investors to shelter their returns from tax. IFISAs may offer the potential for higher returns than traditional savings accounts, but it’s important to know the risks.
Innovative Finance ISAs (IFISAs) are a type of individual savings account where investors can hold money through loans for people or businesses. These can be peer-to-peer (P2P) loans through P2P platforms or debt-based securities, where you invest in a business’s debts through crowdfunding platforms. As an IFISA is a type of ISA, the income you make is sheltered from tax.
Peer-to-peer lending has had its share of negative headlines. Yet while the number of subscriptions into IFISAs in 2019/20 fell slightly by just over 10% from the previous tax year, the average amount held was £12,882, up from £8,632 the previous year, so there is still appetite for them..
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 P2P 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 and cons of IFISAs
- You can start investing with as little as £10, and you can transfer money in from other ISAs.
- There’s no tax to pay on interest earned from P2P lending, and you can put in up to £20,000 each tax year.
- You could potentially get attractive returns from this type of ISA. Of course, these returns aren’t guaranteed, but there is the potential to get higher rates of return.
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.
- P2P platforms can go out of business. The Financial Conduct Authority (FCA), a financial watchdog has clamped down on the sector so that 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.
- 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. There is no Financial Services Compensation Scheme (FSCS) protection ifa P2P platform collapses.
- 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.
How to compare and choose an IFISA
Before you invest, it’s essential you understand where your money is going. This will show you the level of risk associated with your IFISA and what protection is in place if any borrowers default on their loans. Make sure you are also clear about any fees charged by the P2P lending platform.
If the Innovative Finance ISA doesn’t feel right for you, there are alternatives. A stocks and shares ISA lets you invest in a wide range of assets such as investment funds, bonds and individual stocks to potentially grow your money, while a cash ISA will give you a guaranteed rate of return.
With a cash ISA or a stocks and shares ISA, you are also covered by the FSCS against a provider collapse for up to £85,000 (so long as you choose a regulated fund provider). This doesn’t mean you are covered if your investments in a stocks and shares ISA underperform – that’s just the risk you take when investing. There is no FSCS protection with an Innovative Finance ISA.
How do I set up an IFISA?
After doing your research, you can open an IFISA through the provider's website and deposit money. You must be over 18 to open an IFISA.
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.
You can pay into only one IFISA each tax year, but you can split your ISA allowance, which is £20,000 in the 2022/23 tax year, across one of each type of ISA including the IFISA. You can transfer money from another ISA into an IFISA.
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
Holly champions clear, jargon-free writing. She’s been creating finance content for leading organisations for over 10 years. Read more