On April 6th 2016, a third type of ISA will be launched, joining the existing cash ISA and stocks and shares ISA. The new Innovative Finance ISA (IFISA or IF-ISA) will allow investors to hold peer-to-peer loans within their tax-free ISA allowance, increasing the returns available to investors as income tax is not charged on the interest earned.
The introduction of this new ISA is great news for investors who have been stuck with low interest rates from cash ISAs in recent years and who don’t want to navigate the risks and instability of investing in a stocks and shares ISA.
How do you open an IFISA?
Investors will be able to open an Innovative Finance ISA (IFISA) online directly through a peer-to-peer lending platform, or through a fund platform which sells investments to retail investors. When opening an IFISA through a fund platform you may have the option to choose a ready-made investment portfolio, as well as the option to choose your investments yourself. P2P platforms allow you to choose who you lend to based on information about the borrower, but some platforms match you to borrowers themselves so it is important to consider the level of control you want when choosing an IFISA provider. It is expected that only P2P platforms that have received full permissions from the FCA (The UK Government’s Financial Conduct Authority) will be able to offer an Innovative Finance ISA, so they may not be on offer from all platforms by April 6th.
The current annual ISA allowance of £15,240 will also apply to the Innovative Finance ISA, and you will be able to deposit money into an IFISA or transfer it from other ISAs that you have previously opened. The whole allowance can be used to invest in peer-to-peer loans, or you can split it between the IFISA, the cash ISA and the stocks and shares ISA in any combination.
What are the benefits?
The launch of the Innovative Finance ISA will greatly benefit investors by providing a greater choice of tax-free investments. This will allow investors to diversify their investments, splitting their money between higher-yielding options and/or lower-paying safer options.
With the average cash ISA rate currently being lower than 1%, investing in peer-to-peer loans through an ISA will allow investors to enjoy higher expected returns while not paying tax on interest earned. However it is good to remember that peer-to-peer lending will still not be covered by the Financial Services Compensation Scheme. P2P offers net returns much higher than cash ISAs, typically between 5-10%, which are set to get even better when the ISA makes tax-free returns available.
Investors who currently invest all of their tax-free allowance in a Cash ISA may want to consider investing part of a future tax-free allowance in the new Innovative Finance ISA, thus increasing portfolio returns. And investors who generally invest in stocks and shares ISAs may benefit from less volatility and more certainty of returns than the stocks and shares ISA – especially given the current economic climate!
For investors who already use peer-to-peer lending platforms, the Innovative Finance ISA could significantly increase the interest they earn, particularly for the highest rate taxpayers who previously would have had 50% income tax deducted from interest earned on loans. The introduction of the Innovative Finance ISA will also benefit small businesses and individuals looking for a loan as it is set to increase the number of peer-to-peer investors, making more finance available for borrowers.