Last Updated on October 25, 2022 by
The government introduced ISA to encourage people to invest and save. There are several types of ISAs available such as cash ISA and Stock and share ISA. in 2016, a new kind of ISA was introduced named as innovative Finance ISA or IFISA. The IFISA allows people to use their annual allowance to lend money by investing in peer to peer lending. You can have an IFISA account alongside the cash and stock and share ISA. You can put money in each type of ISA for a specific time every tax year. Here in this article, we are going to describe what IFISA is, how it works and how you can invest your annual allowance in p2p lending in a tax-efficient way.
Innovative Finance ISA
An innovative Finance ISA is the type of ISA that consists of peer to peer loans instead of cash or stock and shares. It helps you to make p2p investments within a tax-free wrapper. It means that the interest you earned from P2p loans is not subjected to tax. The IFISA allows you to earn more money by investing in such asset classes. P2p lending is becoming very popular among investors, and you can make more returns by investing your annual allowance in it. When you invest in peer to peer loans, you will receive returns in the form of interest. Many providers in the UK offer you to open an IFISA account and start earning tax-free interest.
How Does IFISA Work?
An innovative Finance ISA works by lending your money to the individuals or businesses for a predetermined time, and in return, you will receive interest. The amount of interest varies with the credibility of the borrower and the amount of time for which you lend money. You can invest a part or whole of your annual allowance in IFISA. Currently, the annual allowance is £20,000. It means you can invest up to £20,000 in any combination of IFISA, cash and Stock & shares ISA per tax year. A tax year is from 6th April to 5th April. A basic rate taxpayer can receive up to £1000 as tax-free interest, while a high rate taxpayer can earn £500 tax-free interest from peer to peer lending.
The Risks Associated With IFISA
The innovative Finance ISA might be beneficial for many investors, but there are also some risks associated with it. Although you can earn more interest, it is riskier than the cash ISA. some of these risks are as follows:
An innovative finance ISA works by lending money through p2p loans. It means that the risk of borrowers default is present. Sometimes a loan goes bad, and the borrowers could not repay the amount borrowed. In this case, there are chances that you may lose all your investment.
Unlike cash ISA the peer to peer loans are not protected by the Financial Services Compensation Scheme (FSCS). It means that if an IFISA company or platform collapses, your capital is at risk. The government does not provide any cover or insurance when you invest in P2p lending.
Interest Rate Not Guaranteed
Many p2p platforms quote high-interest rates with their loans but keep in your mind that there is no guarantee on this interest rate. There are chances that the borrower, in the end, does not afford to pay the high interest or the capital. Thus you may end up losing the profit or all your money.
Slow Withdrawal Process
You should be aware of the fact that the process of cash withdrawal from innovative finance Isa accounts is slow. You may have to wait for a long time to get access to your money. If you need quick access to cash, you must think of investing in any other investment type.
No doubt IFISA and peer to peer lending are considered at a high-risk spectrum but remember that high-risk investments usually means a high potential of returns. However, the choice of investing in an IFISA depends on your risk tolerance.
Can You Transfer Other ISAs Into IFISA?
You can transfer money between different ISAs but make sure that there is no restriction by your IFISA provider. Transfer of funds between ISAs can not affect your annual allowance. However, keep in mind you are only allowed to transfer a full amount and not a part. So, you must think carefully before making a decision. For example, if you want to transfer your stock and share ISA to IFISA, you need to sell your shares first to get the cash. Therefore make sure that it is an excellent time to sell your stocks. Moreover, you should transfer funds through your IFIA provider. If you withdraw cash yourself, it may affect your annual allowance and also expose your investment to tax.
How Many IFISAs Can You Have?
You are only allowed to open and invest in one IFISA account every tax year. However, you can invest in stock & share ISA and Cash ISA in the same year, but you have to make sure that your total investment does not exceed your annual allowance. You can transfer your previous tax years ISAs into your Innovative Finance ISA account.
Who Provides Innovative Finance ISA services?
Many peer to peer platforms offer you Innovative Finance ISA services. The market is filled with new and old providers. Different providers offer different interest rates and lending options. We suggest you do research and select a provider with a good track record and competitive interest rates. Here are some well-known names in the market who offers IFISA:
- Funding Circle
- Lending Works
Once you make a decision to invest in an innovative finance ISA, you have to choose a peer to peer lending platform offering you to invest your annual allowance. Make an account and deposit your funds. Your funds are then lent to people who are looking for loans for a set amount of time, and in return, you will start earning returns in the form of interest. However, while investing, you should keep in mind both the risk and rewards and take measures to reduce risks.
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