The complete Innovative Finance ISA (IFISA) guide

 
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What is an Innovative Finance ISA (IFISA)?

Introduced by the government in April 2016, an Innovative Finance ISA (IFISA) allows you to use some (or all) of your annual ISA allowance to invest in debt-based securities - such as bonds - and loan funds through the peer-to-peer (P2P) lending market, all while receiving tax free interest and capital gains.

To be eligible for an IFISA, you must be a UK resident aged 18 or over. IFISAs are targeted towards experienced investors who are willing to take more risk with their investments in the search for better returns.  

With an IFISA, you’ll usually create an online account which enables you to choose which debt-based securities or loans you invest in. Since the introduction of the IFISA, many P2P platforms have worked alongside the Financial Conduct Authority (FCA) to become authorised to offer it, and there are now a large variety of IFISA providers to choose from. Not all IFISA providers are P2P platforms, but they must all be authorised by the FCA, with approval from HMRC to act as an ISA manager. 

While IFISAs have a lot of benefits - including the offer of high returns, typically between 3% to 15% per year - they are an investment product, not a savings product, meaning your capital is at risk and returns are not guaranteed. 

It’s generally accepted that the higher the return, the higher the risk. This is one reason why IFISAs are able to offer higher returns - because there is always risk associated with investing in a business or project. For example, the business or project could fail, meaning investors get little or none of their money back.

IFISAs are also able to offer higher rates of return than those offered by banks on regular savings accounts because they cut out the middleman - the bank - operating online with generally lower overheads. This cuts costs, which often translates into lower rates for borrowers, and higher returns for investors. 

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What are the different types of IFISA?

IFISAs were created to allow investors to invest in debt-based securities and loan funds through the P2P lending market while receiving tax free returns, and there are a number of different types of investment that can be accessed through an IFISA. This gives investors plenty of choice, and can help with portfolio diversification - one of the most important principles of investing.

While you’re only able to add funds to one IFISA per platform per year, you can invest in a range of businesses or projects on a platform that offers pooled funds - as long as you don’t exceed the annual ISA allowance - with each type of investment offering varying rates of return with a varied amount of risk. Or, you can open a new IFISA account - that focuses on a different element of the sector - each year. 

The main types of IFISA are;

  • Property
  • Green energy
  • SME lending
  • Consumer lending
Property

Property IFISAs enable investors to loan money to fund property projects - including residential development and commercial development - while receiving tax free returns. Investors then receive interest payments at regular intervals, and are paid back the amount loaned at the end of an agreed fixed term. This can give investors a relatively certain stream of income, although capital is at risk and returns are not guaranteed. 

The demand for new homes is growing - with around 250,000 homes required to be built per annum - yet house building remains close to historical lows. In 2018, 165,090 new homes were completed, well below the amount needed to keep up with demand. 

Historically, small house builders were a critical part of the supply market, however they are now struggling to compete with national house builders due to a lack of access to development finance. Property investments, which can be accessed through an IFISA, can offer house builders an alternative source of finance.

As with any investment product though, property IFISAs carry risks. There’s the risk that borrowers will default on their loans, due to circumstances including delays in construction or increased costs. Each property IFISA provider will generally have their own systems in place to minimise this risk, and investors should always look at a providers due diligence procedures and track record before deciding to invest with them. 

Many property investments, such as mini-bonds, are asset-backed. This means that your investment is secured on the assets - such as the land the properties are built on. In the event of the development company going bust and the borrower failing to pay back your money, your capital can be repaid via the sale of assets.

Green energy

With a green energy IFISA, investors can support renewable energy projects - such as hydropower stations and wind farms - while receiving tax free returns.  

While doing their bit for the environment, investors can earn average returns of 3% to 15% through green energy IFISAs. However, since the government scaled back green energy subsidies, green energy IFISAs have become somewhat more risky. Without the government funding, companies will be looking to investors for an alternative form of finance, with the high rate of returns an eye-catching element - though capital is at risk and returns are not guaranteed. 

The huge concentration on combating climate change in recent times is likely to increase demand for renewable energy generation, and green IFISAs are increasingly popular because - with the world becoming more environmentally conscious - they offer investors an ethical investment choice.

SME lending

One of the most popular products offered by IFISA providers, SME loans allow investors to lend money to small and medium sized businesses. Owners of SMEs may need funding for a variety of things, including hiring new staff or boosting cash flow. 

SME lending IFISAs allow investors to fill the gap in the SME funding market caused by the increasing difficulty - post-financial crisis - that SMEs are facing when trying to secure loans from banks. 

With average returns of 4% to 15% and the opportunity to support up and coming businesses across different sectors and geographical regions, SME lending IFISAs offer investors the potential of generous returns and crucial portfolio diversification. 

The risks attached to SME lending IFISAs include the chance that investors will not get any of their investment returned. SME businesses - particularly start-ups - by very definition do not generally have a long track record of success, and there’s always the possibility that they will fail. 

Unsecured SME loans, which are not asset-backed, often offer higher rates of return, but also carry more risks. Secured SME loans can carry slightly less risk as the business has pledged assets to protect the lender from the possibility of loss, but investor capital is still at risk.

Consumer lending

Consumer loans (aka personal loans) are offered - usually by P2P platforms - to customers who struggle to find reasonably-priced loans elsewhere, and they make up a large chunk of the P2P market. 

Being approved for a consumer loan through a P2P platform is usually a little easier than being approved by a traditional bank, and they generally come with lower costs too - including lower interest rates and usually no application fees. This helps with cost and approval, two of the biggest challenges borrowers face when applying for consumer loans. 

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When and why were IFISAs introduced?

Introduced by the government in 2016, IFISAs are one of the latest additions to the ISA family. 

Before the introduction of the IFISA, many investors were beginning to take advantage of the growing P2P lending and debt-based securities market, but couldn’t do so through an ISA. 

Investors were required to declare their income from P2P investments to the taxman (typically via a self-assessment return), with the gains being taxable at the individual’s margin rates.

The government also noticed that everyday investors - who did not want to take the high risks associated with investing in stocks and shares - were faced with unattractive low returns on regular savings accounts.

So, IFISAs were introduced, making investments into debt-based securities and P2P lending tax free, which boosted investment into SMEs and offered investors a mid-risk investment option with the opportunity for higher returns.

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Who can open an IFISA?

To be eligible to open an IFISA, you must be a UK resident aged 18 or over.

IFISAs are investment products, and investing into MAVEN Bonds with an IFISA is restricted to experienced investors classified as either sophisticated or high-net-worth individuals who have the knowledge and experience to make their own investment decisions - in line with rules put in place by the FCA. Other platforms may allow everyday (restricted) investors to invest, but this should be checked on an individual platform basis.

Though investing into mini-bonds through an IFISA is now restricted, everyday investors may still be eligible to invest into other types of IFISA - such as SME lending, consumer lending and green energy - though the FCA states that everyday investors new to the P2P sector must not invest more than 10% of their investable assets. If you’re unsure about your investor classification and whether you’re eligible to invest, you should speak to an independent financial advisor and check with individual platforms about their eligibility criteria. 

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Who are IFISAs suitable for?

IFISAs are aimed at experienced investors - such as sophisticated investors or high-net-worth individuals - who are happy to take a higher level of risk in the search for better returns. 

IFISAs offer better returns than is available through a Cash ISA, but it’s important to remember that unlike a Cash ISA, IFISAs are an investment product and not a savings product, and so they carry significantly more risk. However, IFISAs don’t have the volatility of a Stocks and Shares ISA, which are subject to the fluctuations of the stock market. 

When considering an IFISA, you should consider your risk profile. Keep in mind that IFISAs are not protected by the Financial Services Compensation Scheme (FSCS), your capital is at risk, and returns are not guaranteed. It’s important that you consult an independent financial adviser about your investment goals and return requirements, considering the potential impact that risk could have on your current and future investments.

When investing with an IFISA, your money is often locked away for a fixed term - generally between two and five years - and will usually not be readily realisable, or will incur penalties for early access. So, if you think you may need access to your funds before the end of a fixed term, an IFISA is most likely not for you. 

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How do I open an IFISA?

If you decide that an IFISA could form a useful part of your investment portfolio, opening one is simple. There’s plenty of choice online, and once you have read the offer document of an IFISA eligible investment, you’ll have the option to continue with an IFISA. You can then open your IFISA online and your investment will be included within it. You’ll also have the option to include future investments made through this platform. 

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How many IFISAs can I have?

You are only able to add funds to one IFISA per year, and only one IFISA account can be opened per platform, per tax year. 

You can however hold an IFISA alongside other forms of ISA, providing the amount you deposit across all of your ISAs does not exceed your annual ISA allowance - which is £20,000 for the 2019/20 tax year.

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Can I withdraw money from an IFISA?

All IFISA providers will have their own rules in regards to withdrawing funds. Many will not allow the withdrawal of funds from an IFISA until the end of the specified term, while others may charge a penalty if you choose to withdraw any deposited money early. 

It’s important that you check with your IFISA provider what their withdrawal rules are before making any commitments. 

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Can I transfer an existing ISA into an IFISA?

Yes, you can transfer funds from an existing ISA into an IFISA. 

If you are transferring money invested in an ISA during the current tax year, you must transfer all of it. However, if you are transferring money invested in an ISA during a previous year, you can choose whether you transfer all or only part of it, and you can transfer it into multiple different IFISAs if you would like to. 

For example, if you had accumulated £30,000 in a Cash ISA over previous tax years, you could transfer £10,000 of in into one IFISA, £10,000 of it into another IFISA and then the final £10,000 into another IFISA. Alternatively, you could transfer the whole £30,000 into one IFISA, or split the £30,000 between an IFISA and another type of ISA, such as a Stocks and Shares ISA. 

It’s important to note that you cannot transfer stocks and shares into an IFISA, only cash. So, if you are wanting to transfer your Stocks and Shares ISA over to an IFISA, you must sell the stocks and shares that it holds first. 

While all providers are required to allow you to transfer your ISA from them to another provider of your choice, not all providers will accept transfers. You should check that your preferred provider is open to transfers before agreeing to make the move, and you should make sure you’re following the transfer guidelines set out by your provider to make sure your funds do not lose their tax free status. 

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Are IFISAs safe?

Any investment involves an element of risk, with the possibility that you may not get back some or any of your invested funds. 

On a scale of lower to higher risk, IFISAs would sit in the middle - the medium/high risk section. You can compare this to Cash ISAs, which are lower risk, and Stocks and Shares ISAs, which are higher risk. 

This means that IFISAs generally offer higher returns than a Cash ISA, hand-in-hand with higher risks, while offering lower returns than Stocks and Shares ISAs, but with less volatility as they are not subject to the fluctuations of the stock market. 

The biggest risk with an IFISA is that the borrower lending your funds will default on their loans. To help alleviate this risk, bonds are commonly asset-backed, meaning they are secured on the assets - such as land, if it’s a property bond - so your capital can be repaid via sale of these assets if the project was to fail. However, even asset-backed security does not fully protect your capital. In the event of default or an economic downturn, the security held doesn’t guarantee the return of your capital.

The risks related to an IFISA will also depend on the sector or industry that you are investing into. For example, because they are often asset-backed, property bonds are considered some of the safest. On the other hand, SME businesses could be one of the riskiest, as they come with a high risk of failure - especially when compared to more established businesses. 

You should also thoroughly research the platform offering the IFISA, evaluating how well it has  assessed borrowers and it’s track record. Another important consideration is the fees the platform charge, not only to you - the lender - but to the borrowers. If it seems that the borrower’s rate is significantly higher than the rates you are being offered, you may not be getting a fair return for the risks associated. 

It’s also important to remember that IFISAs are not protected by the FSCS, unlike Cash ISAs which are covered for up to £85,000 if the provider was to go bust, and you must feel comfortable with having this level of risk in your portfolio before going ahead with an IFISA. 

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Is an IFISA right for me?

If you’re an experienced investor, an IFISA is worth considering. But before you take the leap, there are some important questions you should ask yourself when deciding whether an IFISA is the right form of investment for you;

  • What’s your risk profile, and how much risk do you want to take with your investments? It’s important that when deciding where to invest your money, you have an understanding of your risk profile, and that you base your investment choices around this. It’s always advised to speak to an independent financial advisor in the first instance, so they can determine your attitude to risk and recommend the best investments for you.
  • Are you prepared to take additional risk for the potential of higher returns? Because they are an investment product, IFISAs carry more risk than Cash ISAs - which are a deposit product - and returns are not guaranteed. IFISAs do generally offer higher returns than Cash ISAs though, so you must decide whether you’re prepared to take the risks associated with an IFISA for the potential of higher returns.
  • What are your investment ambitions and goals? Your investment ambitions and goals are an important determining factor in your investment decisions. If you have short term goals, you’ll likely want to take as little risk as possible and will need your funds to be easily accessible. However, if your goals are longer term, you may be more open to taking more risks, and will have the capacity to lock away your funds for a longer amount of time.
  • Do you need a fixed income or to be sure of a minimum return on your investment? IFISAs can potentially offer a fixed income as returns are often calculated and paid on set dates. However, as IFISAs are an investment product, these returns are not guaranteed. If a borrower were to default on their loans, you may not get back the money invested.
  • Can you afford for your investment to be tied up for a number of years or do you want the reassurance that you can access them at any time? Generally, investing in an IFISA means locking your money away for a fixed term, and you often will not be able to access your funds until the end of this term. So, if you’re not confident that you won’t need access to your money quickly and easily, an IFISA may not be for you.
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What are the rules of an IFISA?

The main rule - or feature - of an IFISA is that they allow investors to invest in debt-based securities and lend funds through the P2P lending market while receiving tax free interest. However, there are other important rules that must be considered when deciding whether to invest with an IFISA. These include;

  • You can invest up to £20,000 in an IFISA.
  • You can split your annual ISA allowance across multiple ISAs, including IFISAs.
  • There is no limit on the amount you can transfer into an IFISA from other ISAs.
  • You cannot hold stocks and shares in an IFISA.
  • When transferring an IFISA, you should contact the provider to find out how to do so safely without the funds losing tax free status.
  • Equity-based crowdfunding securities cannot be held in an IFISA.
  • Debentures and other debt-based securities can be held in an IFISA.
  • IFISAs are not covered by the FSCS.

For a more detailed understanding of the rules surrounding IFISAs, head to our IFISA rules page, or read our blog on the main rules of IFISAs