The introduction of the Innovative Finance ISA (IFISA) cannot come soon enough. From next spring, people who lend money via peer-to-peer (P2P) platforms such as Zopa will be able to put just over £15,000 a year in a special new ISA which will shield their returns from income tax.
The new tax regime was announced earlier this year by George Osborne in his summer Budget after months of planning and consultation by Treasury officials, and the IFISA has been widely welcomed by financial experts.
The IFISA and the rest
The new scheme stands an excellent chance of success if the latest figures from the Bank of England are any guide: this week, the Bank published data showing that the average annual return on cash ISAs had fallen to its lowest level since records began in 2011. In August, the typical interest rate on such accounts was just 1.43%.
As we discussed in a recent blog post about the Bank of England’s intentions for interest rates, of a rise in the base rate – which could lead to better savings returns – appears to be as distant as ever. So against this background, how will the IFISA fit into the current system of tax-free saving and investment?
How to choose the right ISA for you
The traditional rule of thumb for working out whether to put money into a deposit account versus investing it in the stock market has involved weighing up your attitude to risk as well as what your goals are.
So if you are planning to save for retirement say, or for your new baby’s college education, a stocks-and-shares ISA is likely to be more suitable as the investment timeframe is long enough to ride out any early volatility – and the returns are generally expected to be better than on cash.
If you’re putting money aside for a new car or next year’s holiday, on the other hand, equities might not be such a good idea as you might have lost money by the time you come to make your purchase. In such a case, a standard savings account or cash ISA has in the past been more appropriate.
The IFISA: weighing risk and return
But now there is a third option: lending directly to other individuals through an IFISA. P2P loans offer the opportunity to make considerably higher returns than on cash, with a bit of extra risk – but still less than you would face in the stock market.
At the moment, the typical expected returns offered by Zopa are 5% a year after fees and bad debts for customers who lend for between four and five years. Compared with the 1.43% average cash ISA return cited by the Bank of England, this looks particularly attractive.
And as long as you are happy to take on this extra risk, P2P lending can be suitable for both the short and the long term. P2P loans don’t carry the same volatility as stock market investments, so they can be an appropriate way to put money aside for a forthcoming wedding, say, or even just a rainy-day fund.
A level playing field for P2P
And the more generous returns on offer mean that P2P can also be an option for building up substantial capital over the long-run perhaps as an alternative to a pension or a child trust fund.
The case will be made even more compelling by the new IFISA: it means that interest on loans will not be eaten away by income tax, and finally, P2P will be able to compete on a level playing field with cash deposits and equity investments.