An innovative finance ISA is the fourth type of individual savings account that exists for adults alongside stocks and shares ISAs, cash ISAs and the lifetime ISA. Here is how the innovative finance ISA works.
An innovative finance ISA lets you use your tax-free ISA allowance while investing in peer-to-peer (P2P) lending.
P2P lending is a form of investing where you lend money directly to borrowers and businesses by using an online portal for the exchange of cash. The borrowers then pay back the borrowed amount, with interest on top.
The interest they pay is the return you get on your investment. You earn this interest tax-free.
Investors (IFISA holders) are matched up with borrowers. A borrower could be a business, an individual or a property developer.
So, with an innovative finance ISA, your ISA account contains P2P loans. With a cash ISA it contains cash and with a stocks and shares ISA it contains stocks and shares.
Lifetime ISAs are a form of cash or stocks and Shares ISAs available exclusively to 18 to 40-year-olds for the purpose of buying a home or saving for later life. Anyone eligible for a lifetime ISA can put in up to £4,000 of their allowance each tax year until they turn 50 and get a 25% boost to their investment.
An IFISA works by lending your money to borrowers in return for a set amount of interest. The calculations are based on how long you’re prepared to leave your money untouched for.
You’re allowed to pay your full ISA allowance into your innovative finance ISA, if you choose to. For the current tax year, the ISA allowance is £20,000. The tax year runs from 6th April to the 5th April.
While an IFISA can be great for some people, there are also lots of risks associated with having one.
It’s a much riskier option than a cash ISA, although you could earn more interest. You can reduce risk by spreading your cash across multiple loans.
The risks include …
Defaulting: An innovative finance ISA works like a loan. That means there is a chance the borrowers could default on their repayments.
Inadequate contingency fund: Most of the companies that offer innovative finance ISAs have a backup or reserve fund set up. It’s a way of protecting your money against any borrowers who default on their repayments. But you should be aware that this fund may not cover you if multiple borrowers default at the same time.
No FSCS protection: Innovative finance ISAs aren’t protected under the Financial Services Compensation Scheme (FSCS). This means your money could be at risk if you save with an IFISA online portal that goes bust.
Slow cash withdrawal: If you want to withdraw money from your innovative finance ISA, the process can be slow. You may have to wait some time before you can access your money.
When it comes to choosing an innovative finance ISA, you need to look at factors including:
How long you’ll have to tie your money up for
What return you’ll get
The online platform or portal’s track record
How risky a bet is the borrower
You’re looking for high returns and low (or no) fees, plus a reliable IFISA portal.
You can only open and pay into one IFISA at a time. But you can also pay into other types of ISA, too.
So you could have one cash ISA, one lifetime ISA, one stocks and shares ISA and one innovative finance ISA all open at once.
You just need to make sure you don’t exceed your ISA allowance across all your ISAs. Your ISA allowance is £20,000 for the current tax year.
For example, you could pay £5,000 into a cash ISA, £3,000 into a stocks and shares ISA and still pay in up to £12,000 into an IFISA. The amount in each ISA can be split however you like, as long as it doesn’t exceed £20,000 across all three.
You can also keep earning returns from innovative finance ISAs you've opened in past tax years, or close them to take your money out, but you can't pay into more than one at a time.
It’s also possible to transfer your ISAs from previous tax years into separate innovative finance IFISAs. But you can only add further funds, using your current year’s allowance, into one per tax year.
Yes, you can. But you should check for any restrictions with your existing ISA provider, so you can make sure you won’t be penalised for transferring.
You can transfer all of your cash and stocks and shares ISA money into an IFISA. It takes up to 30 days. But there are rules around transfers into innovative finance IFISAs. These include:
If you’re transferring this year’s savings from your cash ISA or stocks and shares ISA, you have to transfer the full amount.
If you’re transferring savings from older ISAs that aren’t from this year, you can choose how much to transfer. It won’t affect your ISA allowance for the current year at all.
Ask the IFISA provider (the online portal or platform) that you’re switching to for a transfer form. They’ll do the rest. You definitely shouldn’t withdraw the cash, because when you put it back in, it could affect your ISA allowance for the year.
There are several P2P lenders currently offering a service for IFISA investors. However, many platforms are still waiting for full Financial Conduct Authority authorisation. Until they get that, they can’t offer IFISAs.
Of these, some have already announced their headline rates ready for when they get FCA authorisation. This is worth considering if you’re looking for an investment opportunity in the future.