ISA & P2P lending: how does it work?
Making your savings work sounds like a smart idea.
Yet, even newbies know that the taxation policy plays a big role here, to say the least.
Sometimes tax charges may override all the financial benefits you thought you could yield.
But if you are a UK citizen, ISA, an individual savings account, is a reliable tax-free alternative.
In a nutshell, it allows investing up to £20,000 per year without being taxed.
Let’s find out together how it works and why it is claimed to be especially useful for P2P lenders.
ISA stands for Innovative Savings Account.
It’s a savings account that lets you earn interest from your investments without paying any taxes. The only restriction is the amount of money you can save during a tax year. Currently, the limit is £20,000.00.
ISA was introduced two decades ago to help people make some savings. Today there are four types of ISAs:
- Cash ISA: works like a standard savings account. One puts cash in and receives interest.
- Stocks & Shares ISA: the name speaks pretty much for itself. Instead of simply saving the funds, one can invest in stocks, shares, bonds, commercial properties, etc.
- Lifetime ISA: is meant for people who want to save for their first home or retirement.
- And, finally, IFISA, or Innovative Finance ISA allows consumers to lend their funds through P2P lending while earning tax-free interest.
What is an IFISA?
As mentioned earlier, an innovative ISA is a savings account meant specifically for peer-to-peer loans. Simply stated, one can lend funds and receive tax-free interest. Just like any other ISA type, the maximum investment in an IFISA is £20,000.00.
P2P lending and IFISA
IFISA is most often associated with P2P lending since it has become one of the efficient passive income sources.
These two concepts seem to be a match made in heaven. So let’s have a quick look at what P2P lending ISA connection is.
P2P lending, also known as “social” or “crowdlending”, enables individuals to get loans from other individuals, eliminating the financial institution as the middleman and extra bureaucracy.
For borrowers, lack of extra paperwork means better chances to get the funds needed.
For lenders, investing in P2P loans offers more attractive interest rates.
As you may see, it’s a win-win approach for both parties.
Essentially, IFISA is a tax wrapper which means that any growth in the investment will not be subject to taxation.
In fact, it was established in 2016 as a response to the growing demand for tax bonuses for people building their income on investments.
How does IFISA work?
If you are 18 years old and you are a UK citizen, then you are eligible for opening an IFISA account.
Any type of ISA can be held in one person’s name. The option to have a joint account is not available.
What’s also important, you can invest the yearly allowance into any combination of cash, stock & shares, and P2P loans. And again the interest you receive will be not taxed and will be your net earnings.
But what happens if you’d like to invest more? Any investment that exceeds the yearly allowance will be subject to tax. Some examples with numbers may come in handy to get a full idea.
What are IFISA risks?
First and foremost, one should realize that any kind of investment is a risk, be it P2P lending or the stock market.
In terms of P2P lending ISA, the main risks are investing on an unreliable platform that turns out to be a scam; or lending to a borrower that goes bankrupt.
To reduce these risks it’s vital to choose a trustworthy P2P lending website.
A reliable platform has some protective measures in place to protect its lenders, like verifying their borrowers for creditworthiness and providing buyback guarantees.
The buyback guarantees mean that the lender gets their money back within 60 days or so, in case the borrower is unable to pay back the funds.
From the legislative side, FSCS (Financial Services Compensation Scheme) doesn’t apply to P2P loans or IFISAs.
That’s why, just like with any other business, it all comes down to doing one’s homework and going with a reliable P2P lending platform.
On the whole, P2P loans and IFISA are associated with higher risks compared to bonds. Yet, stocks & shares, on the other hand, are still considered to be riskier.
So ultimately, it’s up to you to choose the risk level you feel comfortable trying.
- Can I hold an IFISA and another kind of ISA?
- Yes, you can have an IFISA along with other ISAs. But do keep in mind that the yearly investment amount must not exceed £20,000.00.
- Can I have multiple IFISAs?
- The general policy does not allow operating more than IFISA per year.
- What kind of returns can I expect from an IFISA?
- It depends on IFISA providers. The highest returns offer 8% – 10% these days.
- Can I transfer the assets from my other types of ISA into my IFISA?
- Yes, you can. Your IFISA provider should handle it for you. However, you can transfer only the full amount. There is no option to divide it into parts.
- Can I connect my existing P2P loans with my new IFISA?
- Currently, there is no such alternative.
IFISA is a relatively young phenomenon.
Yet, it’s safe to say that there is a growing demand in the area of passive income and tax benefits tied to it.
So we are likely to see new regulations emerging.
In the meantime, we recommend you do the research and consult with your financial advisor before making any investment decisions.
Hope we can help you with the first part through our blog!