Flexible ISAs can be a great way to save or invest your money, while still being able to access it if you need to.
So, what is a flexible ISA? Find out what you need to know right here.
- Innovative Finance ISAs are peer-to-peer lending products that can be used to lend money between individuals, businesses, or property developers.
- As a type of ISA, returns are Income Tax- and Capital Gains Tax-free.
- Money contributed to an Innovative Finance ISA counts towards your annual ISA allowance, just like Cash ISAs, Stocks and Shares ISAs, and Lifetime ISAs (LISAs).
- Funds deposited into an Innovative Finance ISA in previous tax years can be transferred between different ISA accounts without affecting your ISA allowance.
- Innovative Finance ISA products are typically not protected by the Financial Services Compensation Scheme (FSCS).
What is an Innovative Finance ISA?
Innovative Finance ISAs are tax-efficient accounts that can be used for peer-to-peer lending.
Using an Innovative Finance ISA account, you can lend money via peer-to-peer platforms – this means there is no disparity in authority between the two parties, as opposed to a bank lending to an individual.
A peer-to-peer investment provider connects two parties who are looking to lend or borrow respectively and matches them based on the relevant parameters of their needs. This might include the sum of the loan, its term, the interest rate, and the type of collateral.
Using peer-to-peer loans can be preferable to some borrowers as it cuts out the bank as the middleman between them and potential lenders.
Meanwhile, willing lenders can often benefit from higher rates on their loaned money than they might receive from a cash savings account.
However, there is often greater risk associated with Innovative Finance ISAs when compared to traditional savings accounts.
A significant reason for this is the innate risk that dealing with loans carries. There is always a risk that a borrower defaults on the loans, meaning you could lose your entire investment.
Similarly, peer-to-peer platforms are typically not covered by the Financial Services Compensation Scheme (FSCS). The absence of FSCS protection means you are unlikely to get your money back should something happen to the provider.
In the past, some of these platforms have collapsed and lost users’ funds in the process. You should be aware of the additional risk of losing your capital before lending your money through an IFISA.
How does an Innovative Finance ISA work?
An Innovative Finance ISA works by the holder lending directly to individuals or businesses. Returns from IFISAs are generated by the interest charged on the amount of money loaned to a borrower.
Anyone can open an IFISA with an Innovative Finance ISA provider, including individuals, businesses, and property developers. You can then find a suitable borrower through a peer-to-peer lending platform.
While peer-to-peer lending platforms may not be regulated, IFISAs are still a type of ISA. This means that the funds you pay into your Innovative Finance ISA will contribute to your annual ISA allowance. In the 2022/23 tax year, this is £20,000.
In addition to this, you can transfer into an IFISA from other ISAs without affecting your annual ISA allowance, so as long as the funds are from a previous tax year.
If the funds were deposited in the same tax year, you must transfer the full amount you contributed. You can only transfer between ISAs once a year.
However, you should make sure not to withdraw to your bank account first – doing so could mean you’ll lose this portion of your ISA allowance.
Each year, you can open one Innovative Finance ISA with one provider. At the start of a new tax year, you can then open another account. However, you will only be able to contribute money to one of your accounts in a single tax year.
It’s also worth noting that Innovative Finance ISAs usually involve long waiting times for withdrawals – these can be up to 30 days.
Included in these difficulties is the struggle that could arise when trying to sell or liquidate your loans. For starters, this is because you need a buyer to purchase it from you if you want to sell it before the end of the loan.
This may be especially true if the loan is performing badly, meaning other lenders are unlikely to want to pick it up.
This means that you should have reserve or emergency funds prepared to cover your everyday costs in the event that you can’t withdraw your fund when you need to.
Loan to gross development value (LTGDV) is a popular way for borrowers to collateralise the loans they take out, with properties acting as a method to create margin.
Finding an IFISA provider
A lot of Innovative Finance ISA providers are based online. You can generally open and manage your account online as well.
According to Forbes Advisor, IFISAs were introduced in April 2016, meaning that they are still a relatively young investment product. For this reason, there isn’t a huge range of providers that offer Innovative Finance ISAs.
In your decision-making process, it could be useful to prioritise reputable providers with better histories of customer service and financial security.
There may also be varying investment fees that you should consider.
Can you transfer an Innovative Finance ISA to a Cash ISA?
You can transfer funds between various, existing ISA accounts. These include Cash ISAs, Lifetime ISAs (LISAs), Stocks and Shares ISAs, and Innovative Finance accounts. This can make it a relatively simple process to reorganise your savings accounts should you wish to.
Nowadays, transferring can often be done online – permitting that your bank or account provider allows this.
An Innovative Finance ISA lets you transfer funds from an existing ISA. However, you must first notify your provider to inform them of your wish to transfer. From here you will likely need to fill out an ISA transfer form with the relevant details.
For this, it could be useful to gather any ISA documents or necessary details you may have, including your bank details and National Insurance number.
If you withdraw your funds without informing your provider, you will lose that portion of your annual ISA allowance for that tax year.
ISA transfers between Cash ISAs should take no longer than 15 working days – although other types of transfers can take up to 30 calendar days.
In the case of Innovative Finance ISAs, you can transfer cash from the account, however, you may not be able to transfer other types of investment.
- You can’t transfer money you deposited within the same tax year, unless it is the full amount you deposited
- You can transfer some or all of your funds in existing ISAs if they were deposited in a previous tax year
- Funds transferred between ISAs will not affect your annual ISA allowance
- Withdrawing ISA funds directly to your bank account first could negatively affect your annual ISA allowance.
Despite the flexibility of ISAs, non-ISA products can’t be transferred between ISA accounts or into one. You may need to redeem them for cash in order to contribute to an ISA.
Are Innovative Finance ISAs covered by the FSCS?
One of the major risks of investing through IFISAs is their lack of coverage under the Financial Services Compensation Scheme (FSCS).
The FSCS is a statutory compensation scheme for insurance and investment failures, offering up to £85,000 compensation for each case with a single provider.
The logo is something investors should look out for when browsing investment platforms, as its presence often means your funds are protected if the provider is unable or unlikely to be able to pay its customers.
However, peer-to-peer investments are not regulated by the FSCS, which means that investors are unlikely to receive any type of compensation if the provider collapses. This means your capital is at risk when using these products.
In the past, IFISA providers have collapsed, taking investor funds with them. Because of this, it’s important to research the track record of platforms before exposing your funds to them – especially as you’ll have no protection from the FSCS.
It could be wise to use those with the safest track record and one with a history of high-quality customer service.
Other risks associated with IFISAs
There are other risks associated with IFISAs:
- Loanees defaulting could result in lost capital
- Variable interest rates may negate your expected returns
- Providers may not have contingency funds that cover your position
- You may not be able to sell your loan to another lender if you need access to your capital.
Additionally, it’s popular among borrowers to use property as a form of collateral. While real estate is often regarded as a safe asset class, property prices are not fixed. This could mean that fluctuation in prices could negatively affect the margin of a loanee.
As a result, this could create problems when it comes to paying the interest or remaining balance. At worst, a decline in a property’s value could force a borrower to default on their loan.
Overall, Innovative Finance ISAs are often viewed as carrying a greater level of risk than a traditional savings account, or other ISA products. The higher rates of return can sometimes reflect this additional risk, but it’s your responsibility to discern your own risk tolerance and invest accordingly.
Pros and cons of Innovative Finance ISAs
- Higher rates of interest than Cash ISAs or traditional savings accounts
- Tax-free returns on interest
- Separate ISAs can be transferred in
- Easy to open
- Can be accessed online
- IFISAs are considered to carry greater risk than traditional investments
- They are typically not FSCS-protected
- Borrowers can default on loans
- There may be difficulty in selling early
Other types of ISA to consider
If you don’t think IFISAs are the right investment for you, it’s still possible to enjoy the tax benefits with different ISAs.
Read about some of the other types of ISA you could consider spreading your ISA allowance across.
Remember: your ISA allowance counts across all your ISAs.
Cash ISAs are a popular type of savings account that also earn tax-free interest.
They could be useful as a risk-averse type of savings product since returns are earned through interest, rather than through the performance of an asset on the stock market. As with all ISAs, any interest generated will be entirely free from Income Tax.
It’s possible to open a maximum of one Cash ISA for each tax year, and you’re able to transfer funds from other ISAs as cash. If you want to transfer from another form of investment ISA, you’ll need to first liquidate your investment.
Stocks and Shares ISA
Stocks and Shares ISAs allow you to invest in a range of assets on the stock market, including:
- Stocks and shares
- Corporate and government bonds
- Exchange-traded funds (ETFs)
- Unit trusts
- Investment trusts
- Open-ended investment companies (OEICs).
Crucially, any investment returns won’t be subject to Capital Gains Tax or Income Tax, making this a tax-efficient way to invest your money.
Generally, these accounts carry greater risk than other ISA accounts as a result of the fluctuating nature of the stock market. There’s always a chance your money will fall rather than rise in value, and you may get back less than you invest.
Lifetime ISA (LISA)
If you’re aged between 18 and 39 and considering buying a first home or making a start on your retirement savings, then a Lifetime ISA (LISA) could be a useful account to consider.
You can open either a Cash LISA or a Stocks and Shares LISA and, as with other ISAs, any interest or returns are CGT and Income Tax-free.
In addition to this, you’ll also receive an additional 25% government bonus on your deposits.
LISAs have a separate maximum annual deposit of £4,000, meaning you could receive up to £1,000 as a bonus contribution each year from the government. Bear in mind that this £4,000 personal allowance does count towards your overall ISA allowance (£20,000 in 2022/23).
It should be noted that the funds in LISAs must be used to buy a first home or withdrawn after you turn 60. If you withdraw your LISA funds for any other reason, you will incur a hefty 25% withdrawal fee. This removes your government bonus plus a little extra.
Innovative Finance ISAs FAQs
Are IFISAs a high-risk investment?
Can I transfer funds from my Cash ISA to an IFISA?