The least popular ISA could turn out to be a hidden gem, as long as you understand what you’re getting into when you open an Innovative Finance ISA
Innovative Finance ISAs (IFISAs) have been around since 2016 and you can use them to invest in a range of places, including peer-to-peer platforms, tax free.
However, if you’ve never heard of an IFISA before, or never considered opening one, you’re not alone as they remain relatively uncommon.
The latest data from the government shows that £81million was put into IFISAs in the year 2023 – 2024, yet just over £31 billion went into stocks and shares ISAs, almost £70 billion into cash ISAs and just over £2 billion into Lifetime ISAs.
Yet these often overlooked ISAs can provide a tax-free way to lend money to businesses, through peer-to-peer platforms, and potentially see healthy returns (although as ever with investing nothing is guaranteed).
Here’s everything you need to know about how they work.
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What is an Innovative Finance ISA?
An Innovative Finance ISA is a tax-free way to invest in peer-to-peer lending platforms.
These platforms allow individuals to lend their money to businesses, or other people, and to receive a return, without having to go through a bank.
The person, or company, you lend the money to repays it, with interest, and it’s a type of investing which is relatively recent. You can often choose who you lend money to, such as a start-up business, a property developer or a community project.
The interest you earn on the money you’ve lent is tax-free when you use an IFISA. You can put up to £20,000 into an IFISA, which is the full ISA limit for the current tax year.
In comparison, a stocks and shares ISA lets you invest in things like stocks, shares and bonds, while a cash ISA is a way to save money and earn interest. The returns you make if you’re using an ISA are not taxed but there are limits on the amount that can be within one.
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Why would you open an Innovative Finance ISA?
An Innovative Finance ISA is an investment product, and it’s suited to people who are looking for somewhere with a potentially higher return than a savings account or a cash ISA.
They are most-suited to savers who are:
- Happy to take on more investment risk
- Looking for alternative investments, and a way to support small businesses
- Investors looking to diversify their portfolio.
However, they aren’t right for those who want a guaranteed return, prefer traditional savings or investments, or those who may need to access their money at short notice.
What are the risks of an Innovative Finance ISA?
Some of the risks of using an IFISA include:
- Investment risk: as you’re using an investment product, there are no guarantees on returns and you may end up with less than you put in.
- Defaulting: if you lend money through a P2P platform, there’s a risk the person, or company, won’t pay you back. Most platforms have a plan if this happens, but always check before you sign up.
- Withdrawal times: if you decide you want or need the money you’ve lent back quickly, this might not be possible – although when you sign up you should be told how long this will happen.
- Protection: the Financial Services Compensation Scheme (FSCS) does not yet cover IFISAs. This means if you lent money to a company that went into administration, there’s no guarantee you would get this back.
What are the protections?
Most P2P companies or platforms have protections in place to protect the money people are paying into them. This could be ring fencing the money in a separate account, for example, or having a back-up account to pay out if a borrower defaults on a loan.
However, this depends on the company you’re using so always check the small print first and make sure you’ve thoroughly researched the company.
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What is the average return on an Innovative Finance ISA?
It’s impossible to give a figure on returns as there are lots of companies offering IFISAs, however one of the largest, Easymoney, says average returns are between 4% and 8%.
This is significantly higher than the average returns on cash ISAs or standard savings accounts, which rarely reach 5% and are frequently below 4%.
Most IFISA providers will give a ‘target rate’ which they advertise, although the actual rate someone gets is not guaranteed.
How to choose an IFISA?
The best type of IFISA for you will depend on things like how much money you want to put away and how you feel about investment risk. A few things to think about include:
- How much risk is involved with the money you are putting in and what is the likelihood that you will make a return – you can often check the default rate of an IFISA provider which should give you an idea of the risks involved
- When do you need your money back, how long will it be until it’s paid out, and will you be able to access it earlier if you need to
- Are there any initial or ongoing fees you will need to pay?
- Is there a minimum deposit you need to make?
- What are the target and average returns of the provider?
- Are you just lending to one company or individual or will your money be split up and given to lots of borrowers?
- Where is the online platform or company based, what are its customer reviews like, and what are people saying about it on social media feeds
How many IFISAs can you open?
There are no limits on the number of IFISAs you can open within a tax year. You can also have one alongside a different type of ISA, such as a cash or stocks and shares ISAs.
The main rule is that you don’t go over the annual £20,000 limit across all of your ISAs.
Can you transfer an Innovative Finance ISA to a Cash ISA?
Yes, you can transfer an Innovative Finance ISA into a Cash ISA but there will be rules to follow. This is because the loan will need to be settled and then transferred into cash and there may be fees to pay as well.
You can also transfer an Innovative Finance ISA to a Stocks and Shares ISA in some cases, although this depends on the provider.
If you want to transfer a Cash or Stocks and Shares ISA into an Innovative Finance ISA you may be able to do this but you’ll need to go through the ISA provider – otherwise you may lose some or all of your annual allowance.
