Using the Innovative Finance Isa - should you open one?

Published by Adam Williams on 23 August 2017.
Last updated on 23 August 2017

Using the Innovative Finance Isa - should you open one?

With low rates on cash savings across the market, is it time to consider using an Innovative Finance Isa (IF Isa) to get a better return on your cash?

Launched in April 2016, the IF Isa gave savers a means to invest tax-free in the peer-to-peer (P2P) market for the first time.

There are now more than 50 providers offering IF Isas – including some of the better known names in the market such as Crowdstacker, LendingCrowd, Lending Works, and Zopa.

In some cases these lenders offer returns of around 5%, much higher than Cash Isa accounts where the highest rate at the time of writing is 2.6% if you lock-in for seven years.

But it’s not just the headline rate you need to consider before opting for an IF Isa.  

How does the IF Isa compare to other Isas?

If you’re used to investing in Cash Isas, there are some important differences to note with the Innovative Finance Isa.

The major difference is that with an IF Isa your capital is at risk and the value of your investment can increase or decrease, depending on how your investments perform. However, the returns on your cash tend to be much higher because of this extra risk.

This means the IF Isa is more akin to a Stocks and Shares Isa. Both are investment products and your funds are not protected by the Financial Services Compensation Scheme (FSCS). With cash savings you are protected up to £85,000 per financial institution.

Plus, it’s worth noting that today’s peer-to-peer market has yet to be fully tested during a financial crisis or a recession.

Mike Allan, director of operations at LendingCrowd, says: “Peer-to-peer investing requires a move up the risk curve away from the protection of savings accounts, which include cover from the Financial Services Compensation Scheme.

“When investors accept the additional risk of investing using peer-to-peer platforms, they may achieve a better return but this comes at a price; volatility of returns will be greater plus access to savings more limited.”

If you choose to invest, remember to always keep aside a pot of readily accessible cash for a ‘rainy day’.  

Why use an IF Isa for peer-to-peer investment?

Many people already invest in peer-to-peer without using the Isa wrapper, so what are the advantages of using an IF Isa?

You can invest up to £20,000 in an Innovative Finance Isa during the 2017/18 tax year, and this sum can be split between various types of Isa. For instance, you could save £10,000 in an IF Isa and £10,000 in a Cash Isa during the current tax year. You can also transfer your Isa savings from previous years into an IF Isa if you wish.

By using an IF Isa your investments and any earnings you make will not be liable for capital gains or income tax.

If you were to invest outside of the Isa wrapper, all interest earned from peer-to-peer lending is subject to capital gains and income tax, although the Personal Savings Allowance means most people won’t pay tax.

Under this scheme, lower rate taxpayers can earn £1,000 in interest before being taxed while higher rate taxpayers have a £500 annual allowance. Additional rate taxpayers receive no Personal Savings Allowance, meaning Isa investments are particularly attractive to this group.

Mr Allan adds: “Over time, the compounding effect of retaining and reinvesting the tax-free element of the return will have a positive impact on the growth of the portfolio. Investors can also transfer in Isa holdings from existing Isas and many are doing so by taking additional risk by transferring in from Cash Isas as well as reducing volatility of returns by transferring in from Stocks and Shares Isas.”

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