The Peer To Peer ISA (properly known as the Innovative Finance ISA) was introduced in April 2016, and means you can shelter your peer-to-peer investments from tax in the same way as you do can do with cash, or stocks and shares.
As we'll see later, the way it's been implemented isn't perfect. But still, it's great news for anyone who wants higher returns than you can get from a cash ISA, without putting their money into the casino that is the stock market.
In this article, you'll learn:
- What you can – and can't – do with a peer-to-peer ISA
- What risks you need to be aware of
- What to think about when choosing a platform to invest through
- The platforms I've personally selected, and how I've chosen them
The proper name is an Innovative Finance ISA or IFISA, but it's commonly known as a peer-to-peer ISA – which I prefer, because it's more obvious what it refers to. In this article I'll use both interchangeably.
A quick ISA primer
An ISA (“Individual Savings Account”) is a wrapper that you can put around certain investments to shelter them from tax. The government offers these accounts as an incentive to save: think of it as government-approved tax avoidance.
Once you put something inside the ISA wrapper, you'll never be taxed on it.
Of course, the government don't want you to be able to shelter everything from tax, so there's an annual limit to how much you can contribute. At the time of writing in April 2019, it's £20,000 for each adult.
Up until the Innovative Finance ISA was introduced, there were two types that you could split your savings between:
- A cash ISA, which is effectively just a savings account where you don't get taxed on the interest. Because rates on cash are so low and you don't pay tax on your first £1,000 of interest anyway, for most people this is pretty pointless.
- A stocks and shares ISA, which allows you to invest in a wide range of shares, funds and ETFs. This is highly beneficial, because you'd normally be taxed on dividends and any capital gains when you sell.
For more background on ISAs in general, you can read this excellent guide from MoneySavingExpert.
What is a peer-to-peer ISA?
When the IFISA was introduced, it allowed certain peer-to-peer platforms to make their investments available in an ISA wrapper.
The terminology often gets confused, and peer-to-peer lending and crowdfunding get used interchangeably. Basically though, there are two main requirements for a platform to be able to offer a peer-to-peer ISA:
- The platform must be regulated by the Financial Conduct Authority (FCA). This is a requirement for platforms if they want to provide services to everyday customers, rather than just certified “sophisticated investors” or “high net worth individuals”.
- They must offer debt-based securities. This is just a fancy way of saying that they let investors make loans and pay a fixed interest rate, rather than (for example) helping them club together to buy a property.
What are the benefits?
I'm a fan of peer-to-peer in general, and have a substantial amount of funds split across a number of platforms. I like the fact that it pays a higher interest rate than a savings account, while still offering instant access (on certain platforms). This is different from investing in the stock market, where if you need to access to your money at a certain time you might get back less than you put in because the market has temporarily fallen.
There are a variety of different platforms out there, but I favour those who make most of their loans against property because it means the loan is backed up by something “real” with a clear value. My full article on peer-to-peer goes into all the benefits, and shares that platforms that I invest with personally.
Wrapping these investments in an IFISA just means you don't have to pay tax on the interest you receive – and this can make a huge difference.
Say you have money invested with a platform that pays an interest rate of 6%:
- If you get taxed at the basic rate, this reduces your interest rate to 4.8%
- If you get taxed at the higher rate, your interest rate falls to 3.6%
To put it another way, say you invested £20,000 in peer-to-peer loans, but outside the protection of an ISA. At an interest rate of 6%, you'd earn £1,200 over a year.
If all that income fell within the higher rate of income tax, you'd lose £480 to tax – whereas in in ISA, you'd lose nothing. That's a big difference!
What are the risks of an Innovative Finance ISA?
The ISA wrapper in itself doesn't change anything about the underlying investment, so the risks are exactly the same as if you invested in these platforms outside an ISA.
The main thing is: don't make the mistake of thinking an IFISA and a cash ISA are equivalent in terms of risk. They're not. When you lend money through peer-to-peer, you're not protected by the Financial Services Compensation Scheme (FSCS), which means if you lose money there's no guarantee you'll get it back. It's unlikely but possible that you'll get back less than you put in: if it was risk-free, you wouldn't get such an attractive interest rate.
Actually though, there is one extra hidden risk that comes about as a result of the ISA structure:
How many peer-to-peer ISAs can you have?
You can only open one new peer-to-peer ISA in each tax year.
This is understandable from an admin point of view, but annoying. It prevents you from diversifying across platforms, which is a way of reducing investment risk. So if you want to use your full £20,000 ISA allowance for peer-to-peer lending, it would be sensible to split it across four different platforms in £5,000 chunks – but you can't. Instead, you have to choose just one platform for the full £20,000.
However, you can open one of each type of ISA in any tax year, and split your total £20,000 allowance between each of them.. So you might decide to open:
- An IFISA, and put in £10,000
- A cash ISA, and put in £2,000
- A stocks and shares ISA, and put in £8,000
The “only one platform” rule is an annoying one, but it becomes less of an issue as the years go on. That's because in Year 2 you could open an account with Platform 2, and in Year 3 you could open an account with Platform 3. Now, you have some diversification – so the failure of one platform won't wipe out all your funds.
How to choose a peer-to-peer ISA provider
There are a lot of platforms that offer an Innovative Finance ISA. And unlike a cash ISA where you're just looking for the highest interest rate, you need to weigh up various different factors to decide which is the best peer-to-peer ISA for you.
Platforms marked with an asterisk (*) are those I personally have money with. This isn't an exhaustive list, but should give you a good starting point.
|Platform||Interest rate||Loan types||Quick access||Self-select or automatic||Minimum investment||Transfers in/out|
|* Assetz Capital||Find out more||4.1% - 6.25%||Business and property||Yes (in Quick Access Account)||Both available||£1||Yes|
|* Ratesetter||Find out more||2.9% - 6%||Business and consumer||Yes (in Rolling Market)||Automatic||£1||Yes|
|Landbay||Find out more||3.19 - 3.54%||Buy-to-let mortgages||No (but a secondary market is available)||Automatic||£5,000||Yes|
|Lending Crowd||Find out more||5.6 - 6%||Business||Yes||Both available||£1,000||Yes|
|Funding Secure||Find out more||10 - 16%||Property||No (but a secondary market is available)||Self-select||£25||Yes|
|Lending Works||Find out more||5 - 6.5%||Consumer||Yes (fee applies)||Automatic||£100||Yes|
When making your decision, here are a few factors you might want to look at:
1: Who do they lend to?
Do they lend to small businesses? Individuals? Property investors for small projects? Property developers for large projects? These all have a completely different risk profile, and you might have a preference about who you prefer to lend to.
2: What interest rate will you receive?
It isn't straightforward to work out which platforms pay the best interest rates, because there's no standard way of reporting the interest rate that investors receive. Some platforms will deduct fees and the impact of bad debts before arriving at a figure, and others won't.
To complicate matters further, on many platforms every investor will have a different combination of loans inside their portfolio – so the platform can only publish an “average”, which some investors will over-perform and others will under-perform.
Really though, what matters is risk-adjusted returns: in other words, are you being paid a decent amount for the risk you're taking on? For example, a 3% interest rate for a loan portfolio of long-term buy-to-let mortgages might be OK. The same 3% for a portfolio of unsecured loans to consumers with poor credit ratings wouldn't be good at all.
How involved do you want to be?
Some platforms will let you select the underlying loans you invest in – like which businesses to lend to, or which property projects to fund. Others will choose a selection for you, giving you diversification across a range of the loans on their platform.
Some people like the control of picking their own loans, while others (like me) just want to be given a broad range and not have to think about it. It's a matter of personal preference.
Can you get early access to your funds?
A loan can be made for a period of a few months to a few years. So what if you want to get your money back before the loan repays?
Some platforms will have a “secondary market”, where you can sell your parts of loans to other investors. Others will just let you submit a withdrawal request, then do some magic matching behind the scenes to sell your loan parts for you.