Innovative Finance ISA vs Cash ISA
An Individual Savings Account, or ISA, is used by savers and investors to store capital, earning interest tax-free. The tax-efficient wrapper has traditionally come in two primary forms: Cash ISA and Stocks & Shares ISA. The former is utilised by retail savers and the latter by retail investors who want to maximise earnings from their stock market investments.
In April 2016, the Innovative Finance ISA (IFISA) was launched. This new ISA product allows investors in the lucrative peer-to-peer lending market to take advantage of the tax incentives offered by an ISA.
Your £15,240 ISA allowance (2016/2017) can be invested across a peer-to-peer lending platform (that is fully FCA authorised and HMRC approved), earning some of the best interest rates on the market – 6% per annum average – with no requirement to pay tax on your returns.
At present, only Crowdstacker and Crowd2Fund offer IFISAs through their respective websites. Several more platforms will have the IFISA by the close of the tax year, including Lending Works and Landbay who have recently been fully authorised by the FCA, and, in Lending Works' case, HMRC approved.
There are rules governing the Innovative Finance ISA, and ISAs more generally. One primary rule applied to any ISA product is that you cannot subscribe more than your annual allowance per tax-year. This means that should you subscribe £10,000 to a Cash ISA in 2016/2017, then you only have £5,240 left to subscribe to a Stocks & Shares and/or Innovative Finance ISA.
*The annual ISA allowance will increase to £20,000 for 2017/2018 tax year.
For more on the rules surrounding the IFISA, visit our 'IF ISA' tracker page.
Below we will take you through some of the benefits of investing through an IFISA, comparing to the perks of a Cash ISA.
One of the biggest differences between IFISAs and Cash ISAs is the vast gap in potential interest rates offered.
Let’s take a look at some of the best cash ISAs currently on the market.
Moneywise.co.uk, November 2016
Now, let’s compare with what are considered to be some of the best alternative investment rates around. The rates displayed do not take into account fees and bad debt.
Orcamoney.com, December 2016
ISA Portfolio Example
If you were to spread your annual tax-year ISA allowance between a Cash ISA and an IFISA, you could develop a portfolio which is more weighted to the higher rate IFISA product, but has a reasonable fail safe in the more secure Cash ISA product.
In the example below, we have a portfolio weighting of 66% Innovative Finance ISA (Crowdstacker as provider) and 33% Cash ISA (Pargon Bank as provider).
This portfolio balance equates to almost your entire 2016/2017 annual ISA subscription allowance - £240 remains.
P2P investment: Burning Night Loan
Interest rate: 7% p.a
Term: 3 Years
Deposit: £10,000 (of annual ISA allowance)
Annual return: £700 tax-free
NB: With Crowdstacker, you are responsible for selecting your own investment. The Burning Night Loan is one of two available investments currently advertised on the platform.
For more information on the Crowstacker IFISA, read: 'Crowdstacker Innovative Finance ISA'
Paragon Bank 3 Year Fixed Rate ISA
Interest rate: 1.2% AER
Term: 3 Years
Annual return: £60 tax-free
You may be reluctant to balance your portfolio this way if you have no experience in peer-to-peer lending. Risk appetite is something you need to determine yourself, but research and analysis like that offered by Orca could help you ascertain the level of risk you're willing to take.
Risk & Security
With all P2P investing comes risk. The principal risk is that you lose all of your capital with no protective coverage from the Financial Services Compensation Scheme (FSCS).
The FSCS can compensate customers of UK authorised financial services firms if they have stopped trading. It protects deposits & savings (up to £75,000), investment businesses, home finance, insurance policies and insurance broking.
Despite being authorised by the FCA, peer-to-peer lending is not covered by the FSCS. You are risking your capital.
While dozens of peer-to-peer lending platforms wait to take the step from interim permissions to full FCA authorisation (allowing them to apply to the HMRC for ISA Plan Manager status), two P2P providers have already been fully authorised.
Both Crowdstacker and Crowd2Fund list SME business loans on their platforms. As an investor you are responsible for selecting the loan(s) you wish to invest in, via your Innovative Finance ISA.
*P2P lending is not covered by the FSCS. There is a chance you could lose your capital.
Investing through an IFISA allows you to achieve returns in the region 5% + without having to pay any tax on interest received. With the higher rewards on offer comes higher risk; no FSCS protection.
A well balanced ISA portfolio is critical and could ensure that you achieve the yield you desire, while holding some of your annual subscription allowance in the less risky asset of cash. Bear in mind, there are only two P2P platforms currently offering IFISAs, but with more and more lenders receiving full FCA authorisation, 2017 will surely be a year where the IFISA comes to fruition.
Visit our 'IF ISA' tracker page to see who offers the IF ISA now