There are a lot of different types of ISA available for the savers, and one such option is Innovative Finance ISA. The other categories include in cash ISA, cash & stocks ISA and lifetime ISA. Unlike cash ISA, the IFISA allows you to make tax-free investment through peer to peer lending. In this blog, we will explain everything you need to know about peer to peer loans and ISAs, everything from benefits to risks.
What is peer to peer loans?
Peer to peer lending has become quite famous in the past few years as a lot of people have become interested in earning more interest than they can from traditional low-interest banks savings account. Platforms like Kuflink and Zopa provide individuals the capability to invest their funds as loans to small individuals and businesses, earning interest over time since the funds are paid back. These firms may appear similar to a traditional bank savings account, but the function is quite different.
What is an IFISA?
Essentially an Innovative Finance ISA is an investment with a tax-free wrapper. The tax wrapper of ISA means that any return on your investment will not be subjected to tax that you usually would have to pay on the interest. This way you can make more money.
How does an IFISA works?
When you open an Innovative Finance ISA, it forms part of your complete ISA allowance for that tax year, that is £20,000 for 2020/21. This means you invest all your allowance in any combination of cash ISA, stocks & shares ISA or IFISAs. Opening an Innovative Finance ISA account means that you can invest up to £20,000 through peer to peer loans in an ISA tax wrapper, so you wouldn’t have to pay any tax on the returns that you earn through your investment in peer to peer lending.
Returns from peer to peer loams forms part of your personal savings allowance. Thus, you will be only responsible for tax on bigger investments. Here is an example of how this investment works.
John has invested £50,000 in the peer to peer loans. First, he used his complete ISA annual allowance of £20,000, and then he used the remaining £30,000 to invest in peer to peer loans outside the ISA. All of the p2p loans pay a 5% interest rate. He earns a total amount of £1,500 interest from non-ISA loans. Of this interest, £500 is taxable at the rate of 20%, so John had to pay £100 in tax, brining his total returns to £1,400. Meanwhile he earned £1,000 in interest, all of which he got to keep.
But, if ED has invested his complete £50,000 in peer to peer loans outside of ISA, his total tax bill would be £300. Hence, using an Innovative Finance ISA ultimately saved him £200 for that tax year.
Is it possible to have an Innovative Finance ISA along with another type of ISA?
Yes, you can have an Innovative Finance ISA account along with another type of ISAs, only if your total investment in one year doesn’t exceed the limit of £20,000. In addition, you can just pay into an Innovative Finance ISA in every tax year. While, you can have multiple investments simultaneously, but you can only pay into one each tax year.