An innovative finance ISA is a just an ISA that gives savers a tax efficient way to earn interest on peer-to-peer lending.
The ISA works in the same way as cash ISAs and stocks and shares ISAs – providing somewhere to save where the money can grow tax-free.
To understand an innovative finance ISA – sometimes called an IFISA – savers first need to know how the different components of the scheme work.
Peer-to-peer lending explained
Peer-to-peer lending, or P2P lending for short, happens on a specialist online platform that matches investors willing to lend money to borrowers who could be individuals, businesses or property developers.
The P2P platform generally screens – or risk assesses – the borrowers and sets a limit on how much money they can have and the interest rate they will pay.
Because P2P lending cuts out the middleman, so no banks are involved, savers typically earn more interest than they would putting the same amount of money in a savings account.
To reduce the risk of a lender losing all their stake, the platform spreads their money across several borrowers. Most platforms have a contingency fund to compensate lenders if a borrower fails to repay their loan.
The platform charges a fee for arranging and managing the loan.
Investors can lend directly to borrowers through a P2P platform outside an IFISA but would pay income tax on interest earned over a certain level.
Is an IFISA right for me?
Depending on your tax status and how much you want to lend determines if you need an IFISA.
Anyone paying income tax at the basic rate (20%) or higher rate (40%) can earn some interest each year tax free under the personal savings allowance.
The allowance covers P2P lending as well as interest earned on cash savings, so don’t forget to add in savings income from all sources when working out if the allowance covers your lending.
For basic rate taxpayers, the limit is £1,000 and for those paying at the higher rate, the limit is £500.
To earn £1,000 from P2P loans posting a return of 5% a year, an investor paying basic rate tax must have the full limit of £20,000 held in an IFISA. The limit drops to £10,000 for a higher rate taxpayer.
Whether a saver needs an IFISA depends on three factors:
- The rate of income tax they pay
- How much they intend to save in the IFISA
- The rate of return expected from the loans
Finding an IFISA
IFISAs are a fledgling market – they only came into being in April 2016.
Because of the newness of IFISAs, the number of providers is small and mainly restricted to specialist platforms.
Many are also crowdfunding platforms offering alternative finance options to start-up entrepreneurs or platforms linked to buy-to-let and other property developers.
The Consumers Association lists many of the currently available IFISAs, the sectors they invest in, minimum investments and anticipated returns. The table is updated quarterly – the last revision date is at the foot of the table.
Is money safe in an IFISA?
IFISAs and P2P lending are regulated activities in the UK under the auspices of the Financial Conduct Authority, which means providers must comply with the rules and keep client money separate.
Understanding your ISA allowance
Savers have an ISA allowance of £20,000 a year.
Don’t forget this is for all ISAs held in the financial year, not each type. The allowance can be for an IFISA or split across cash or stocks and shares ISAs in any amount in each, providing the £20,000 limit is not broken.
Savers can open one of each type of ISA each financial year.
Transfers into an IFISA
Savers can only open a single IFISA each financial year with one provider.
Any money saved in a cash or stocks and shares ISA can be moved to the IFISA without any charges or tax penalties.
Making a transfer comes with some rules:
- Any savings switched between ISAs opened in the current financial year must be for the full amount
- Any savings switched between ISAs opened in earlier tax years can be for a partial or full amount of the balance in the ISA
- Move savings by completing a transfer form from your provider
- Beware of transferring money between ISAs as this could impact your annual allowance
- Stocks and shares held in an ISA must be sold before the transfer and reinvested into P2P lending as cash
- Transfers can take up to 30 days, especially if share sales are involved, so make sure the switch has time to take place before the end of the financial year
Can current P2P loans be transferred between IFISAs?
You cannot just switch current personal P2P loans outside an IFISA into the tax-free environment, you must find someone who wants to take them over, pay any charges and then restart the loan inside the IFISA.