Innovative Finance ISA (IFISA): What is it and how does it work?

The UK government introduced the Innovative Finance ISA in April 2016 to enable individuals to earn tax-free returns on their loans.

What is an innovative finance ISA or IFISA?

Innovative Finance ISA is also known as peer-to-peer (P2P) lending. It is a type of individual savings account where investors can hold debt instruments and peer to peer loans. This type of ISA allows individuals to lend money to companies or individuals without a bank. In addition, interest earned on such loans is tax-free, making it a perfect ISA wrapper.

Innovative Finance ISA is the best ISA for crowd financing. It offers funding that would otherwise be difficult for small business owners with little collateral to get from the banks. Investors use a third party to loan various people funds for a pre-determined interest rate. One can earn stable returns through the innovative ISA while supporting the UK economy.

The funding circle innovative finance ISA

The funding circle ISA is an Innovative Finance ISA that enables individuals to lend to established small businesses in the UK and earn tax-free returns. Investors can choose to lend to a pool of people at a fixed interest rate or to various individuals or companies at different rates.

Funding Circle Innovative Finance ISA is a good alternative for small and medium enterprises as they get sidelined by the banking sector due to strict terms and conditions. Moreover, the Innovative Finance ISA allows one to invest in various types of investors, thereby gaining varying interest rates thus giving investor diversity.

Who offers innovative finance IFISAs?

Peer-to-peer platforms offer Innovative Finance ISA. Various categories of peer-to-peer lending platforms give access to the IFISA. Some platforms lend to small businesses, while others lend to individuals and property developers. The platform matches potential lenders with borrowers who can trade within the tax year.

The online platform enables borrowers to gain funds quickly and without tedious bank processes. Based on the peer-to-peer lending platform, an individual may be required to give a list of guarantors to shield the lender from the risk of default.

How does innovative finance IFISA allowance work?

Currently, the UK government has capped all ISAs at £20,000. That means that in any tax year,  an individual can only invest no more than £20,000 across the various types of ISAs. Individuals do not have to invest the £20,000 at once but can make multiple contributions to an ISA within the tax year. However, it is worth noting that you cannot surpass the ISA limit of £20,000. Often, the investment company refunds the excess cash to your account; they don’t invest the extra amount.

If you own each type of ISA, you can split the £20,000 ISA allowance across your ISA accounts like this:

• Cash ISA: £8,000
• Stocks and Shares ISA: $10,000
• Lifetime ISA: £4,000
• Innovative Finance ISA: £6,000

Through the online peer-to-peer platform, the investor can look for individual borrowers or a pool of borrowers. The peer-to-peer platform helps lenders assess the risk level of every potential borrower, which helps determine the interest rate that would apply to each individual. It is worth noting that the investor may receive the repayment at varying periods.

Innovative finance ISA rules and comparison

The people who can invest in IFISA have to be UK residents and above the legal age of 18 with a National Insurance number. Like other types of ISAs, you can only open one IFISA account each tax year. However, you can only make new monetary contributions to a single IFISA in a particular tax year. You can open an innovative finance ISA with a different peer-to-peer platform each tax year. There is no limit to how many IFISA accounts you can hold concurrently.

There are a few differences between IFISA, cash ISA and stocks and shares ISA. First, IFISA contains P2P loans, while stocks and shares ISAs have equity invested in the stock market. With cash ISA, cash is the investment.

The Innovative Finance ISA is similar to SIPPs or ISAs. They are all considered high-risk and return investment vehicles. They are dependent on external market factors and can have very high losses, but they could also give an investor a high return. The IFISA is different from a cash ISA, which is low risk and assures people a fixed return within a tax year.

Lifetime ISA requires you to open an account between ages 18 and 39, and stop monetary contributions at age 50, while an IFISA has no age limit for monetary contributions. In addition, like other ISA withdrawal flexibility, IFISA allows people to withdraw money and move it into another ISA.

How do transfers into innovative finance IFISAs work?

Investors can transfer their savings from other ISAs into an IFISA without the transfer affecting their annual ISA allowance. You can transfer part or all of your savings into your IFISA. There are some of the ISA transfer rules:

• If you transfer this year’s cash ISA or stocks and shares ISA into an IFISA, you must transfer the full amount.
• Suppose the transfer is from older ISA accounts from previous tax years. In that case, you can transfer any amount you want into the IFISA without it affecting the current year’s ISA allowance.
• Do not transfer your savings into your IFISA via cash withdrawals from your other ISAs. The deposit will count as part of your annual ISA allowance, limiting how much you can contribute that year.
• Investors should complete a transfer form with an IFISA provider to conduct the process on their behalf.
• IFISA providers must make IFISA transfers in cash: Investments held in stocks and shares ISAs must be liquidated to cash before it is transferred into an IFISA. Therefore, a downturn in the market can cause you to lose money during the transfer, so make sure to initiate the transfer during a market rally.

Check with each IFISA provider for any transfer fees or penalties. The maximum processing time for a transfer into an IFISA is 30 working days.

How to choose an IFISA

You can open an IFISA account on a P2P platform, and there are several companies that offer this type of investment opportunity. However, there are several factors to consider before using an IFISA. They include

• Investment timeframe: How long is your money locked up for
• The return on the ISA investment: What is the interest rate
• The minimum required deposit
• Management cost
• The online lending platform’s track record
• Collateral asset: What asset is securing the loan
• Your risk tolerance: Can you afford to lose some or all of your money
• Withdrawal flexibility: Is there an option to access your money early

What are the risks associated with having an innovative ISA?

The IFISA is associated with very high risks as it is not regulated by the Financial Services Compensation Scheme (FSCS) since it is not a cash ISA or stocks and shares ISA. Therefore, for an IFISA, there is a likelihood that the borrowers will default on their payments.

The Innovative Finance ISA does not assure you of returns. The borrowers have different risks, and some may not recoup their investment to repay you within the agreed time. Further, early repayments can also be risky, denying the investor the much-needed interest return. However, the lender can pre-determine the borrower’s risk level to reduce the likelihood of losing their capital. In addition, lenders can mitigate this risk by breaking down the funds into different loan sizes.

The Innovative Finance ISA is a good alternative for individuals seeking to invest their individual savings allowance. IFISA is likely to give individuals very high returns based on the borrowers and their risk level. Also, a lender may suffer very high losses by lending money to various categories of businesses. The IFISA is not regulated by the Financial Services Compensation Scheme (FSCS), meaning that it has a high rate of default as the money is not protected or guaranteed. However, the peer-to-peer lending platform may match the lender with a low-risk business for a low return, thus assuring the lender of his returns.

FAQ

Are IFISA covered by FSCS?

Even though an Innovative Finance ISA is an ISA wrapper, it is not protected by the Financial Services Compensation Scheme (FSCS) since it is a peer-to-peer loan. However, P2P platforms have their own protection, and most have compensation policies because investment defaults may occur.

Can I have more than one Innovative Finance ISA?

You can have multiple Innovative Finance ISA accounts, but you can only open one IFISA account per tax year.

Can I have a stocks and shares ISA and an IFISA?

Yes, nothing stops you from having a stocks and shares ISA account and an IFISA account. You can have all the different types of ISAs, but you can only open one of each type of ISA every tax year.