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Could 2019 be the year of the IFISA?

For all the resilience the UK economy has shown, there is no doubt that this year's ISA season is set against a backdrop of uncertainty. Whatever the pros and cons, Brexit, and a lack of clarity on what our future economic relationship with the EU will look like, has left us at a crossroads.

Should an orderly withdrawal agreement be rubber stamped by both sets of Parliaments, there is a lot of consensus that Britain could be in for a boom, with business investment in particular set to pick up. UK-based stocks would probably benefit from a bounce; property prices too, and there is a likelihood that interest rates - and therefore returns for savers - will also gradually increase.

However, should the dice fall the other way, and a no-deal Brexit ensue, many experts believe the effects on the economy will be adverse; members of the Monetary Policy Committee have implied that interest rates will need to be cut, and while many FTSE 100 share prices would benefit from the inevitable devaluation of sterling, no one can predict the impact on the wider stock market with any degree of certainty.

Other factors at play

But it isn't just the 'B-word' which is presenting economic challenges. The global economy is experiencing a slowdown. Additionally, trade tensions between the US and China remain unresolved, with no breakthrough in sight. The Italian banking crisis is another red flag, as is the number of major countries experiencing recession, or sitting on the brink of it.

Given the inter-connectedness of the global financial system, all these elements have the potential to unleash significant economic damage. But, equally, if the storm clouds were to clear, a period of prosperity becomes very likely.

For savers and investors in the UK, there are substantial implications with regard to such uncertainty, not least when it comes to ISAs. Do you stick by allocating the bulk of your ISA allowance towards the safe haven of a cash ISA, twist by seeking investment growth in a stocks & shares ISA, or look at other alternatives? Although there are no easy answers, our take is that there is a strong case to be made for the latter option – specifically by investing in an Innovative Finance ISA.

Comparing performance of the four ISA types

Cash ISAs

It wasn't long ago that returns of 4-5 per cent on an easy-access cash ISA were commonplace. However, these have fallen off a cliff since the financial crisis. Cash ISA rates reached their nadir in 2017, with the lowest average return on record, according to Moneyfacts. 

Average Cash ISA Rates Table

These rates have since begun to rebound, while inflation has also levelled off over the past year. Nevertheless, cash ISA returns remain in the gutter, and, unless you are willing to tie up your money for at least three years, cash ISA savings will lose value in real terms if the current rate of inflation (1.8 per cent in January) were to endure.

While an improvement in economic conditions could lead to higher Bank of England rates, and/or a further drop in the rate of inflation if sterling strengthens, the converse is also true. There isn't too much scope for variance in terms of cash ISA performance, and the fact that your money is guaranteed can be a favourable fall-back in the face of such uncertainty. But putting all your eggs into a cash ISA basket is likely to erode your savings in real-terms value for the foreseeable future.

Stocks & shares ISAs

In the midst of an impressive bull run, stocks & shares ISAs delivered average fund growth of 20.4 per cent in 2016/17 - the highest since the 2009/10 financial year, according to research from Moneyfacts. Yet this cooled dramatically to just 4.8 per cent in 2017/18, and the past year has also been a challenging one for investors.

Stocks & shares ISAs have established a reputation for delivering excellent long-term gains, and are therefore a valuable tax-wrapper for savvy investors. But it remains the preserve of a smaller group of people for two fundamental reasons. The first is the element of volatility that comes with such types of investment. Secondly, there is often a large degree of complexity involved, and although platforms and brokers will do much of the heavy lifting, there are considerable fees to contend with.

Lifetime ISAs

This category of ISA came into being in April 2017, with the key selling point being a built-in, Government-backed 25 per cent bonus on all monies saved. You can subscribe up to £4,000 per year into this account, which, given that you can contribute to it between the ages of 18 to 50, means you can accumulate a bonus of up to £33,000 - receivable once you turn 60.

However, uptake fell below Government expectations during 2017/18, with 166,000 accounts being opened (the target was 200,000). Some believe this is to do with the heavy penalties involved with early withdrawal (the bonus, plus interest is forfeited, unless taking the money out to buy a first home). 

However, perhaps the single biggest issue has been the shocking lack of banks and building societies offering a Lifetime ISA (LISA) so far. In fact, there are still just 12 providers at the time of writing, with only three offering a cash version of the LISA.

Innovative Finance ISAs

Despite launching nearly three years ago, a survey commissioned by AltFi last spring found that over 75 per cent of UK adults were unaware of the Innovative Finance ISA (IFISA). Indeed, in its first year of existence (2016/17), just 7,200 accounts were opened, with £36m in subscriptions.

However, this figure rocketed to £290m in 2017/18, across a total of 31,000 new accounts, and there is good reason to believe that growth will be even more exponential within the current tax year. For starters, the same AltFi survey found that 60 per cent of people were aware of peer-to-peer lending (P2P), which has now entrenched itself as the dominant force within the IFISA category. Furthermore, it was found that, of those who had heard of an IFISA, one in six had already subscribed to one, which is a remarkable conversion rate.

But arguably the biggest reason for optimism for the IFISA is the current economic backdrop, and a comparison with alternatives. P2P platforms have a proven track record for delivering stable, inflation-beating returns of between 5 to 10 per cent, with only a moderate amount of risk involved. Additionally, IFISA performance is not directly affected by interest rate changes, stock market movements or wider economic/political stimuli. 

This stacks up favourably against other types of ISA. The returns on an IFISA are overwhelmingly more lucrative than a cash ISA, and while greater income growth can potentially be achieved within a stocks & shares ISA, the value of these investments can go up or down - not to mention that continued volatility remains likely with such jittery markets.

IFISAs: What you need to know

The above makes a compelling case for putting your money into an IFISA, and sitting back while your money grows steadily within this tax-free wrapper. In this section, we deal with some of the key questions you may have.

What is an IFISA?

An IFISA enables you to allocate some or all of your ISA allowance towards peer-to-peer loans, and enjoy tax-free returns. Although this ISA type technically caters for the wider umbrella of 'debt-based securities', online peer-to-peer platforms - which enable you to lend money directly to borrowers in need of a loan – account for almost all available IFISAs at present.

How do I open an IFISA?

The process will vary from platform to platform, but creating an IFISA account online usually takes just a few minutes. You will then need to transfer in money (the minimum can be as little as £10), which should hit your account instantly, or at most within one working day. All that’s left to do is lend this money out to borrowers. Some platforms let you choose who you lend to, while others will adopt the 'double-blind' approach, and allocate the loans on your behalf. 

How do IFISAs work?

After you subscribe your money to an IFISA and commit to lending it, the P2P platform facilitates the transaction, vetting borrowers for creditworthiness, and spreading your money across multiple loans to minimise risk. You then receive repayments on these P2P loans with interest, protected from tax by virtue of being held within an IFISA. 

Due to the fact that intermediaries such as banks are eliminated from the equation, you as an investor benefit from better rates. You also have the flexibility to take returns as an income, or reinvest them to maximise the value of your investment.

How many IFISAs can I have?

You can have an unlimited number of IFISAs, but you can only subscribe to one IFISA, held with one provider, each tax year.

That said, it's worth noting the distinction between subscriptions and transfers: if you are transferring ISA funds that were held within previous tax years, you can split this across any number of IFISAs - even during the same tax year. 

IFISA Subscription Graph

IFISA Transfers Graph 

Are IFISAs FSCS protected?

Unlike cash ISAs (and some investments within stocks & shares ISAs), there is no protection afforded to P2P loans held within an IFISA by the Financial Services Compensation Scheme (FSCS). So, in the event that borrowers default on their loans, and/or the P2P platform goes bust, you will be at risk of capital loss.

However, platforms usually have robust measures in place to counter this. Aside from strict credit modelling and loan underwriting, many platforms will have a segregated fund to cover arrears and defaults. Lending Works, for example, also has an additional layer of protection by virtue of a unique insurance that reimburses lenders for defaults incurred for typical reasons such as illness and unemployment.

Platforms also require full FCA authorisation to offer an IFISA, and many will have a contingency process in place to ensure that their loan book is wound down to maturity in the event of bankruptcy.

How do I choose the best IFISA provider?

Peer-to-peer lending is quite diverse, with different types of loans being facilitated (eg: business loans, consumer loans, secured loans, invoice finance etc), and each carries their own risk profile. It is thus important to take into account the level of risk involved versus the headline rates of return.

Platforms who are members of the Peer-to-Peer Finance Association are obliged to record all key performance statistics such as arrears rates and default rates on their website, and also avail their loan book to site visitors too. Although past performance isn't necessarily a portent of things to come, it does give you a fairly reliable basis upon which to compare platforms.

Is an IFISA right for me?

Deciding how best to spread your remaining ISA allowance for 2018/19 is subject to your personal circumstances, objectives and risk appetite. Yet there is a compelling case for including IFISAs within your investment portfolio. P2P lending has actually been around since 2005, facilitating over £10bn in loans in the UK, and cementing itself as an asset class whose returns are lucrative, steady, predictable, and largely unaffected by external economic turmoil.

Cash ISAs are the most popular type of ISA, but returns remain derisory. Stocks & shares ISAs, meanwhile, are not likely to be suitable for everyone given their complexity, and, at this particular time of uncertainty, will be more prone to fluctuations than usual. And although the LISA has its place, it is something of a niche product.

The IFISA, on the other hand, is simple to open, and requires little in the way of ongoing management. Indeed, the only reason IFISA uptake hasn't been higher until now appears to be an issue of awareness, rather than product quality. But as the IFISA begins to establish itself within the mainstream of financial services, that will start to change - especially given the current economic climate, and the shortcomings of the other three ISA types. 

So, if you're in the market to earn inflation-beating returns from a user-friendly investment product for only a small amount of risk, then the time to invest in IFISAs is now. In all likelihood, there will be many, many people who do the same in 2019.

You may also be interested in: What is an Innovative Finance ISA? IFISAs explained

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