With the government’s new Innovative Finance ISA, it is easier than ever to get involved in peer-to-peer lending. However, it’s important to make the most of what’s on offer, and planning early and investing in an Innovative Finance ISA at the beginning of the tax year will encourage a better return on investments.
What is an ISA?
Introduced in 1999, ISAs have been a hugely popular investment product for everyday investors. Over £480 billion is actively invested in ISAs, with investors enjoying the convenience of being able to shield savings within a tax wrapper and grow their funds tax free.
On 6th April 2016 the government introduced another option for ISA investors: the Innovative Finance ISA. The IFISA is designed to encourage investors to lend directly to British businesses, instead of buying shares or holding cash the IFISA enables investment via Peer to Peer lending.
The addition of the savings allowance in 2016 means individuals can now generate a savings income of up to £1,000 per annum tax free; however, there is no guarantee that this policy will remain. Additionally, the maximum amount of savings income that higher rate tax payers can earn tax free is just £500.
Potential IFISA earnings if invested from the start of the tax year
On Crowd2Fund, one of the only crowdfunding sites currently licensed to offer the IFISA, a full IFISA allowance with an estimated APR of 8.7 percent, utilised from the beginning of the tax year, would generate a return of £1,740 before fees and bad debts.
By contrast, a full IFISA investment of £20,000 deployed in the last month of the tax year under the same set of assumptions would generate a return of just £145.
Other options offered by similar platforms include by p2p property lender Relendex, with lenders choosing which loans to invest in and all secured against commercial real estate property in the UK. p2p lending platform Funding Circle are also set to launch a similar offering.
Start early and invest regularly
Whilst not all individuals will be able to invest their full allowance at once, investing a set amount monthly will let you work towards using up your full IFISA allocation over a period of time, as well as benefitting from tax free interest payments made earlier on in the year.
This will also overcome any issues related to market fluctuations, due to there being a lack of investment opportunities matching the investment criteria of the IFISA holder. Instead investors will be able time the frequency and value of investments to take advantage of their bespoke preferences.
Additionally, investing over a longer period will allow investors to maximise their choices across a range of different opportunities on offer. This will empower them to build a diversified portfolio, which matches their risk appetite, alongside actively participating in the success of businesses which match their particular interests.
Compounding interest
Using up a full ISA allocation at the beginning of the year, or deploying a set amount of funds regularly, will allow investors to generate higher returns due to compounding interest.
This occurs when interest earns money on interest. Reinvesting interest payments into new campaigns is an especially powerful feature of the IFISA due to the additional investments being able to grow tax-free.
For example, the full £1,740 earned over 12 months from fully utilising a £20,000 IFISA, with an estimated APR of of 8.7 percent (before fees and with zero defaults), will accrue an additional £151 over a second calendar year assuming that all interest payments are reinvested.
If these assumptions were to continue for an additional two years, the £20,000 would grow to be worth £25,786.