Are innovative finance Isas worth the risks?

  • Innovative finance Isas invest in P2P loans which can pay attractive rates of interest
  • This type of debt has a number of risks including default, insolvency and lack of liquidity
  • There are fewer P2P options for private investors than previously 

Innovative finance individual savings accounts (Ifisas) have their roots in the fallout from the 2008 financial crisis and credit crunch. At that time, it became much harder for individuals and businesses to borrow from banks and other traditional lenders, at the same time as savers were frustrated by rock-bottom interest rates on their conventional bank accounts. Peer-to-peer (P2P) lenders such as Zopa, Assetz Capital and Funding Circle emerged as attractive alternatives to fill that void. These websites cut out the banking middlemen, acting directly as financial matchmakers between people with cash to lend and personal or corporate borrowers.

The industry has undergone meteoric growth: research by UK innovation agency Nesta and the University of Cambridge found that transaction volumes – the amount of money flowing through P2P lending platforms – grew from less than £100mn in 2011 to £2.9bn in 2015.

To encourage private investors to tap into the trend, Ifisas were launched by the government in April 2016. These are tax wrappers offered by P2P lenders which enable investors to accumulate P2P returns tax free. They can be held alongside cash, stocks and shares, and Lifetime Isas, and you can currently put £20,000 a year into Isas in aggregate.

But it’s worth noting that most investors are not taxed on the interest they receive from P2P loans held outside Ifisas because P2P lending returns are covered by the personal savings allowance. This allows basic-rate taxpayers to receive interest from cash or certain types of debt worth £1,000 tax free, and higher-rate taxpayers to receive £500 tax free.

According to the independent P2P ratings website 4thway.co.uk, this means that basic-rate taxpayers…

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