Innovative Finance ISAs explained: what you need to understand in 2020

At the start of every year, experienced investors look at two points - how they can maximise their investments in the year ahead, and what they can do to improve tax efficiencies before the end of the tax year in just a few weeks time.

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It’s therefore little surprise when it’s explained in recent years, Innovative Finance ISAs (IFISAs) have found themselves a key part of the discussion in both of the above.

Introduced in April 2016, IFISAs essentially allow investors to add peer-to-peer (P2P) lending (or other debt-based securities, including property backed loans) to their investment portfolio through the wrapper of the ever-popular ISA. Each tax year, you can therefore invest up to the ISA limit - currently £20,000, as of the 2019/20 tax year - into the likes of peer-to-peer lending and property bonds, and have any future returns realised tax-free.

An attractive option - especially when you consider target interest rates are generally between 4 and 10% - it’s one that’s only going to become more so as the popularity of certain investment options booms. Looking at P2P lending, it’s reported that in just five short years, the global peer-to-peer market will be worth in excess of $800 billion / £615 billion.

What’s more, in 2019 the IFISA market passed the £1 billion investment mark. A great figure on its own, it becomes more interesting when you note that just three years earlier when they were first introduced, only £36 million was invested via IFISAs. That’s an increase of over 2,600%.

Read more: IFISA investment surged to more than £1 billion in 2019

Yet with all this said, IFISAs still haven’t reached the level of popularity their brothers and sisters of the ISA family have. Cash ISAs are undoubtedly the most popular - they accounted for 72% of all ISA subscriptions in the 2017/18 tax year.

So with 2020 in full flow and the end of the tax year beckoning, what do you need to know as an experienced investor when it comes to innovative finance ISAs?


Doing your IFISA provider research is crucial

This in itself isn’t something new for 2020. When you’re considering any investment product, you need to complete full and proper due diligence, ensuring it’s the right option for your money.

However, as a product becomes more popular - which IFISAs are - it becomes more widely available. Although this has its positives, it also means more providers and products will enter the market. As such, you need to be able to do your research fully to ensure you’re making an investment - which is still what an IFISA allows you to do, regardless of the ‘Individual Savings Account’ tag or its tax-efficiency element - into the best product for your needs.

You need to look at the provider themselves and explore their team. How knowledgeable and experienced are they? What’s their track record for delivering to expectations? What is their ethos and their culture? What are they striving for? Can you feel confident that the underlying assets or projects they’ll invest into will provide the best chance of a return?

Read more:download the IFISA guide

There is always an element of risk involved when investing via an IFISA. An investment product rather than a savings one, it’s why the target returns are generally between 4 and 10 times more than you find with a typical Cash ISA.

To put this into context, if you used your entire £20,000 annual allowance in a Cash ISA, which had a rate of 1.31% (currently the best on the market with free access to your money, as of 30th January 2020), by the end of two years you’d have a total Cash ISA value of £20,527 (interest paid annually and compounded).

However, if you invested the same £20,000 into an IFISA and choose a two year property bond with an interest rate of 6.75% per annum, that same £20,000 could increase to £22,700 (interest paid at maturity). That’s potential for over £2,100 more in returns.

But as the chance of greater returns brings with it greater risk, this is exactly why you need to do as much research as you realistically can to ensure the level of associated risk falls within your individual preferences.


Don't get swept up in the excitement

With an IFISA your returns are not strictly guaranteed. You are making an investment and as with all investments, your capital is at risk and returns may vary. Unlike the Cash ISA, there is no backup if the investment fails to produce a return. However, for many experienced investors, the fact that - in real terms - Cash ISAs are struggling to keep pace with inflation means they are looking for an alternative way to make their money work harder.

As such, when looking at the wider market, many investors find IFISAs provide an attractive middle ground between a traditional Cash ISA, which offers safety but low returns, and a Stocks and Shares ISA, which provides the potential for higher returns, but is subject to the fluctuations of the stock market.

With an IFISA, your investment can often be asset-backed, such as via property. Whilst this doesn’t mean the risk of losing money is fully mitigated, it does mean that in the event of an economic downturn, there is a level of security that may offer an element of protection.

Read more: IFISA: understanding the risks vs the returns

But it’s important to understand that losing your capital is possible. And that understanding becomes even more of a priority as IFISAs increase in popularity, which will no doubt bring with it increased marketing and market awareness.

Be confident you’re doing enough research to know whether you’re making the right decision for your own investment portfolio. Work through the marketing material and look at the figures - does the IFISA you’re looking at have the risk profile and potential rewards to fit comfortably within your investment portfolio?


Minimising tax and maximising returns is becoming more and more imporant

Everyone needs to pay tax of some variety. Taxes make the world go round and are the foundations upon which most successful economies thrive. Yet whilst they can be a cause of frustration towards the government that set them, the UK government does actively encourage and supports people to save and invest for the future.

IFISAs are just one example, and when looking at the wider ISA family (now consisting of Cash, Stocks and Shares, and Junior ISA varieties), savers and investors in the UK have been able to enjoy tax free returns since April 1999, when the Cash ISA was first introduced.

With savvy investors making use of an array of tax efficient investment options available to maximise their returns and minimise tax liabilities, this is something that will only become more important as time goes on.

For instance, mentioning Brexit and the potential repercussions could play an obvious role in your decision to make your money work harder and minimise tax. There are scenarios showing both positives and negatives, but the reality is, we don’t yet know how we will be impacted as individuals financially once we leave the EU.

Read more: IFISAs and tax-efficient investing: what you ought to know

Similarly, the 2020 Budget date has been confirmed - 11th March - and whilst there’s lots of positive talk around income tax, at the other end there are rumours of entrepreneur’s relief being cut, inheritance tax changes and pension amendments. For the last two budgets, the attractive tax reliefs available under schemes such as the EIS and SEIS have both been rumoured to see cuts, too (though neither have as of yet).

Tax changes are often needed for a political party to meet its goals, but that doesn’t make them any easier to swallow, especially if they end up increasing your liabilities.

Whilst none of the above directly relate to IFISAs, the positiveness of the tax-free wrapper can so often be overlooked. ISAs have been available for decades now, and whilst IFISAs are one of the newest members to join the family, it doesn’t make them any less beneficial, for the right investor, from a tax efficient investing perspective.

A £20,000 investment each year, with returns not liable to income tax or capital gains tax, is an extremely attractive proposition, regardless of the size of your wider investment portfolio.


Investing in an IFISA in 2020 explained

The coming months undoubtedly look appealing for IFISAs. Their popularity is increasing, the market will be expanding and for investors, this will invariably be a positive. More choice is rarely a negative.

But as with any investment product, researching IFISA providers and products is critical to you seeing the greatest likelihood of a return on your investment. Understanding what you’re investing into - and through who - can be extremely beneficial knowledge to have and help put you in the best position possible as you grow your investment portfolio - and save tax - during the year ahead.


The Innovative Finance ISA Guide

The CARLTON Bonds product is available exclusively to experienced investors who are classified as either sophisticated investors, high-net-worth individuals or professional investors and have the knowledge and experience to make their own investment decisions. Investments are high risk and illiquid, your capital is at risk and returns are not guaranteed. Bonds are not protected by the Financial Services Compensation Scheme (FSCS).