There are several types of ISAs or Individual Savings Accounts, and the Innovative Finance ISA or IF ISA is one of the newest. Like other ISAs it offers tax-free investing, which means your investment can grow faster because the taxman will not be taking a share of the returns your earnings. Unlike other ISA types, the IF ISA provides investment through the growing Peer-to-Peer lending market. This can offer attractive returns, with the potential to make the best use of your £20,000 annual ISA allowance.
How does an IF ISA work?
Different ISAs use your money in different ways. With an IF ISA your money is used to fund Peer-to-Peer lending. Peer-to-Peer (or P2P) lending is a form of investing which allows people to lend directly to individuals and businesses, without using a bank as a middleman.
Why use an Innovative Finance ISA to invest?
There are of course many types of ISA investments. Cash ISAs allow you to save cash, while Stocks and Shares ISAs allow investment, with greater risk but much more potential for higher returns.
The IF ISA sits somewhere between, and offers higher interest than banks and other financial institutions, without the complications of stocks and share investment
The interest received from Peer-to-Peer loans is taxable, like any other income from an investment or savings. However, by putting the investment into an ISA, you can enjoy the returns without tax. There is no tax deducted from the interest your money earns, and no income tax or capital gains tax to pay when you come to take your money out.
This can make the potentially attractive returns from an IF ISA even more rewarding and could therefore be a very effective way to make the most of your annual ISA allowance.
What are the limits on an IF ISA?
An Innovative Finance ISA is available to any UK taxpayer aged 18 or over, and is subject to the Annual ISA allowance, which is currently £20,000 per tax year. This £20,000 annual contribution allowance can be shared between all types of ISA. So you can have a combination of types of ISA, including a Cash ISAs, Lifetime ISA, and Stocks and Shares ISAs as well as an IF ISA in any one tax year, but your total contribution must not exceed £20,000.
If you wish you can invest your whole £20,000 allowance in an IF ISA. You can invest more in Peer-to-Peer lending, but only the first £20,000 per year can be put inside your Innovative Finance ISA.
You can only open one Innovative Finance ISA account each tax year – but you can have Innovative Finance ISAs with different P2P platforms by opening a new one each tax year.
Is your money safe in an IF ISA?
With a Peer-to-Peer platform you're lending money directly to individuals and companies rather than through a bank as you would with a savings account. There is therefore a risk that the people and businesses you lend to will not repay.
Unlike bank and building society savings or a cash ISA, the money you lend via a P2P platform is an investment, and like a Stocks and Shares ISA is not covered by the Financial Services Compensation Scheme. With normal UK savings, including Cash ISAs, this would pay the first £85,000 of any money saved per person, per financial institution if the institution went bankrupt or had to cease trading. Any money you invested with a Peer-to-Peer platform doesn't have this protection.
However, like banks, Peer-to-Peer platforms factor in an expected amount of 'bad debt', when someone is not able to pay back what they've borrowed. Some P2P platforms have contingency provisions, designed to pay out if a borrower defaults on their loan.
How much can you make in an IF ISA?
The actual returns available from various IF ISA providers can vary.
At RateSetter, our IF ISA offers rates of between 3% and 4%. With some of our products, there are fees which mean a loss of interest. We also offer a bonus of £20 to get you started. Terms apply.
Please note that tax treatment depends on individual circumstances and may be subject to change in the future. Capital at risk. No FSCS protection.