The Government paved the way for Innovative Finance ISA in April 2016. It made Peer-to-Peer lending eligible for inclusion in a tax-free ISA. With even the best Cash ISAs hardly beating inflation, a new type of Cash ISA offering returns of 8% or more sounds very exciting.
But it is only now that providers have launched accounts to choose from. We take a look at the key benefits and risks with the latest addition to the ISA family. Should you consider an Innovative Finance ISA – or IFISA?
What exactly is an IFISA?
Like Cash ISAs and Stocks and Shares ISAs the IFISA keeps your money safe from the taxman.
Unlike existing ISAs, the IFISA is based on Peer-to-Peer lending.
Peer-to-Peer lending simply means lending out your money to other people or businesses. They pay the money back over time, with added interest. This cuts out conventional banks, removing a layer of cost and allowing borrowers to pay less in interest while potentially allowing investors to receive more in returns. It has boomed in recent years, but is not without critics.
What are the benefits of an IFISA?
The appeal of the IFISA is simple enough. Peer-to-Peer lenders offer higher interest returns than bank or building society savings or Cash ISA accounts. Many predict returns in excess of 8% per annum.
What’s more, all ISAs allow you to enjoy all the interest your money earns free of income tax and capital gains tax. So in theory you could enjoy returns of 8% or more on a full ISA allowance of £20,000 from April 2017 and not pay the taxman a penny.
What are the risks of IFISAs?
While an IFISA may appear to be much like a Cash ISA, it is actually not comparable, because it leaves your money at risk.
With Peer-to-Peer lending, the people or businesses you lend to will pay your money back with interest. If they don’t, the provider should deal with the problem. But if the provider itself got into financial difficulties, you would have no protection, because Peer-to-Peer lending is not protected by the Financial Services Compensation Scheme (FSCS).
Unlike a conventional Cash ISA, which is a saving product underwritten by Government backed security, with an IFISA your capital is at risk.
You should think of it as an investment, with no safeguards for your capital.
Will you actually get the full return?
There is another risk. Unlike traditional Cash ISA saving, Peer-to-Peer lending may not deliver a return on lenders’ capital from the moment it is committed. A Cash ISA will pay interest from day one, funds invested into an Innovative Finance ISA will only start to attract interest from the point when it is transferred to borrowers. If the platform took six months to lend out capital, the return would only be delivered for the last 6 months of the year.
How much of a risk is an IFISA?
It may be too early to fully understand the risks of an IFISA.
Peer-to-Peer lenders have pointed out that their approach to credit checking is more thorough than most banks, and that the risk of default is understood, and factored in when setting rates. Most have contingency funds to protect investors from loan defaults.
Should you find out more?
The financial regulators are taking their time assessing the proposals from IFISA providers, which should at least ensure that when a new product is launched it will have been thoroughly vetted. At the time of writing, there are just four products to choose from.
If the prospect of good returns from your ISA investment appeals, it’s important that you fully understand the possibilities and associated risks.
The value of investments can go down as well as up and you may not get back the amount invested. Levels and basis of reliefs from taxation are subject to change.