Innovative Finance ISA Guide - Lighthouse

A handy guide to the 2019 ISA season

As the tax year end approaches, the financial services industry readies itself for a flurry of activity. That's in large part because, with just a couple of months to go, the so-called 'ISA season' is upon us. 

If you make use of fund managers and/or financial advisors, they'll no doubt be in touch, encouraging you to make use of your ISA allowance before time runs out.

Giving due consideration to this is sensible, but making the most of this year's ISA season can be a tricky task. In order to ensure that you go about things the right way, it's best to ensure that your foundation understandings of all things ISA are firmly in place. Below, we answer some key questions you may have…

Section 1: Understanding ISAs

What is an ISA?

An ISA, or Individual Savings Account, is a UK-specific scheme that came into effect in 1999 which allows residents to hold cash, shares and unit trusts in a wrapper, with the individual being legally protected from paying tax on interest, capital gains and dividends on these assets.

ISAs are typically offered by banks, insurers, building societies and the NS&I, and come in the following three primary categories:

1) Cash ISA - A savings account
2) Stocks & Shares ISA - An investment account
3) Innovative Finance ISA - A peer-to-peer account

There are then three further sub-categories of ISA, which are variations of 1 and 2 above:

Junior ISA - A savings and/or investment account available to Under 18s
Help to Buy ISA - A savings account for prospective first-time homebuyers
Lifetime ISA - A (retirement) savings and/or investment account for under 40s. Also available as a savings and/or investment account for prospective first-time homebuyers 

What is an ISA allowance?

Every UK resident over the age of 18 is entitled to a tax-free subscription limit for contributions towards their ISA(s) during each financial year. This annual allowance can be used for subscriptions to any single category of ISA, or collectively across multiple ISA categories.

ISA allowances have soared over the years, particularly in the past decade. This limit stood at £7,200 in the 2009/10 financial year, but has since risen to £20,000 today. So, while it may or may not be possible for you to capitalise on this entire allowance for the 2018/19 ISA season, it is good to know you have significant room for manoeuvre.

What happens if I take my money out of my ISA? 

You are free to withdraw from your ISA at any time. It is, however, important to note that any money subscribed to an ISA and subsequently withdrawn will still count towards your ISA allowance, and cannot be replaced*.

Perhaps more significantly, there are likely to be fees or even penalties involved. Easy-access cash ISAs tend to be the exception, but you will usually incur withdrawal fees from the provider in the cases of fixed-rate cash ISAs, Stocks & Shares ISAs and Innovative Finance ISAs (IFISAs).

Lifetime ISAs are even more punitive, given that withdrawals prior to turning 60 incur a 25 per cent charge - unless it is for the purposes of purchasing a first home, or to fund treatment of a terminal illness.

How many ISAs can I have?

There is no limit to the number of ISAs you can open each tax year, nor a restriction on the number you can accumulate over time. However, you can only subscribe to one provider within each ISA category during each tax year. So, in theory, to accrue more than three additional ISAs every 12 months, you would need to open these via the transfer of old ISA money.

Can I transfer an ISA?

ISA season isn't only about subscriptions, and maximising ISA allowances. Finding the best ISA rates is a key ambition of many savers and investors over this period, and transferring your ISA is an invaluable means of achieving this. There is usually a transfer fee involved, but these can often be dwarfed by improved returns.

An ISA transfer can be done at any time, provided the new ISA manager does accept transfers. ISAs can be transferred between providers within the same ISA category (eg: a cash ISA can be transferred from one bank to another), or across categories. Either way, the process is initiated by you simply completing an ISA transfer form for your new provider.

However, it is essential that you do not withdraw this ISA, or attempt to perform the transfer process yourself via bank transfer, as doing so will result in your funds or investments losing their tax-free status. The transfer process should instead be left to both your new and existing ISA managers to complete. In the case of a cash ISA, this should take no more than 15 working days, whereas you should allow up to 30 working days when transferring to a Stocks & Shares ISA or an IFISA.

Section 2: Maximising your ISA returns

Where can I find the best ISA rates?

ISA rates are a crucial determinant when it comes to deciding where to subscribe funds, or transfer an existing ISA. Yet rates should also be weighed up against risk profile of the prospective ISA provider so as to find the optimal risk-reward balance. The best way to do this is to assess ISAs within each category, as this gives you a better chance of making like-for-like comparisons - or near enough to it…

Cash ISAs: Cash ISAs enjoy protection from the Financial Services Compensation Scheme (FSCS), which guarantees total individual savings of up to £85,000 per institution. In that sense, they offer a high degree of safety, and are by far the most popular category of ISA among UK consumers. Unfortunately, cash ISA rates of return over the past decade have tumbled. The combination of low base rates, the advent of the Personal Savings Allowance and the lack of willing among challenger banks to take on the red tape involved in facilitating them have all conspired to depress interest rates on cash ISAs.

That said, there are signs that this market is beginning to rebound, with the best easy-access cash ISA presently paying an AER of 1.38 per cent. If you're willing to lock your money away (or with restrictions on withdrawals) in a fixed-rate ISA for two years, you can earn an annualised rate of 1.8 per cent, while you can earn up to 2.26 per cent AER when committing your money for five years.

Stocks & Shares ISAs: After a barnstorming run, the stock market has endured a recent correction. Nevertheless, the rule of thumb is that a well-diversified portfolio delivers annual returns of around 6 - 7 per cent, and with the added tax efficiency, Stocks & Shares ISAs carry plenty of appeal - despite the fact that there is no FSCS protection, and the value of investments can go up or down.

Given the wide range of options when it comes to investments and ISA managers, it is difficult to make accurate and meaningful comparisons within this realm. Nevertheless, something to look out for when scoping out Stocks & Shares ISA managers and platforms are charges and fees - particularly dividend reinvestment fees, transfer charges, monthly investing discounts and more.

Convenience and service delivery are vital too, as are tools and information. After all, this is your hard-earned money we are talking about. It is the job of the platform to ensure that you feel well informed of all the relevant parameters before making an investment.

Innovative Finance ISAs: Innovative Finance ISAs are provided by peer-to-peer lending platforms, and came into existence three years ago. Only platforms which are fully authorised and regulated by the FCA are entitled to become ISA managers, so there are fewer providers when compared to the other two categories of ISA.

Nevertheless, peer-to-peer lending and IFISAs have been a revelation in the UK, providing an excellent alternative for those frustrated by the poor returns on savings, and not willing to take on the risk and volatility of stock market investment. Indeed, IFISAs also complement savings and/or investments within individual portfolios. In 2017/18, a total of 31,000 new IFISAs were opened – a six-fold increase on the year before – and it is widely expected that this rapid rate of growth will continue in 2018/19.

Although FSCS cover does not apply to peer-to-peer lending either, platforms typically counter this risk to capital with robust safeguards. And when factoring in the possibility of returns anywhere between 5 and 10 per cent, it is easy to see why IFISAs are growing in popularity.

It is important to note that there is much scope for variance in both the structures and operations of individual peer-to-peer lending platforms, which in turn impacts both risk and reward. One means of gauging the level of risk involved is to assess past performance, which all members of the industry body Peer-to-Peer Finance Association are required to display on their website.

Final thoughts on the 2018/19 ISA season

It is widely thought that an overwhelming majority of ISA subscriptions and transfers take place in the month leading up to the end of the financial year, so now might be the perfect time for you to follow the trend and find the best ISA rates. 

And while cash ISA rates remain derisory, the good news is that the level of choice further afield continues to increase, giving you the best possible chance of diversifying your portfolio and maximising your savings and/or investment income.

Underpinning this diversity is the IFISA, which may yet prove to be the spark that ignites one of the more lucrative ISA seasons for UK consumers. Here's wishing you all the best over the next two months, and that you make savvy decisions so that many more pennies may end up in your pocket!

*Exceptions include Flexible ISAs (which allow withdrawals to be replaced without affecting your ISA allowance) and Inheritance ISAs (whereby ISA balances inherited from deceased spouses can be subscribed by the surviving spouse, separate to the statutory ISA allowance).

Our website offers information about saving, investing, tax and other financial matters, but not personal advice. If you're not sure whether peer-to-peer lending is right for you, please seek independent financial advice, and if you decide to invest with Lending Works, please read our Key Lender Information PDF first.

As with all investments, your capital is at risk.