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Innovative Finance ISA: how the P2P ISA works
The Innovative Finance ISA launched on 6 April 2016 and was, at the time, treated as the thing that would make peer to peer lending mainstream. Interest earned inside one is free of income tax, in the same way interest in a cash ISA is, and for a higher rate taxpayer earning 8 per cent on a loan book that is a meaningful difference.
Ten years on, far fewer providers offer one, because far fewer platforms are left.
The basics
One allowance across all your ISAs. The annual ISA allowance is shared between cash, stocks and shares, innovative finance and lifetime ISAs. It has been 20,000 pounds a year since the 2017/18 tax year, but allowances do change, so check the figure for the current tax year on gov.uk rather than taking it from a page like this one.
Interest is tax free, and stays tax free. No income tax on the interest, no capital gains tax, and nothing to declare on a self assessment return for money held inside the wrapper.
Transfers in are allowed. You can transfer an existing cash or stocks and shares ISA into an Innovative Finance ISA without it counting against the current year's allowance. It has to be done as a transfer, arranged by the receiving provider. Withdrawing the money and paying it back in loses the wrapper on the old money.
Since April 2024 you can pay into more than one ISA of the same type in the same tax year, which means opening a second Innovative Finance ISA with a different provider mid-year no longer breaks the rules. It still has to fit inside the one shared allowance.
Not every platform product is eligible. Peer to peer loans are, and since April 2024 so are Long-Term Asset Funds and certain open-ended property funds. Debentures and mini-bonds sold by some platforms may or may not be, depending on how they are structured. The platform will tell you which of its products can be held in the ISA, and it is worth reading rather than assuming.
What the wrapper does not do
It does not protect your money. This is the misunderstanding the tax-free label creates and it is the expensive one. A cash ISA is covered by the Financial Services Compensation Scheme up to 85,000 pounds per bank. An Innovative Finance ISA is not, because the money in it is lent out rather than deposited. If borrowers default or the platform fails, being inside an ISA changes nothing about what you get back.
It does not make the loans liquid. Money in an Innovative Finance ISA is tied up in loans with terms of months or years. Getting it out early depends on the platform's exit route working, which is exactly the thing that stops working in a crisis.
Bad debt relief works differently. Outside an ISA, losses on peer to peer loans can be set against peer to peer interest for tax purposes. Inside an ISA there is no tax to relieve, so a loss is simply a loss. For an investor with real defaults, the wrapper can be worth less than it looks.
A dead platform is still a dead platform. Several providers that offered an Innovative Finance ISA in 2017 no longer exist. Where a platform failed, ISA money went into the same recovery process as everything else, and transferring it out was not possible while it was tied up in defaulted loans.
Whether it is worth using
For someone paying higher rate tax who was going to lend on these platforms anyway, the wrapper is straightforwardly worth having. It costs nothing extra at most providers and the tax saving is real.
For everyone else, the order of questions matters. The Innovative Finance ISA is a tax wrapper around a decision you have already made. Whether to lend at all, and to whom, is the decision that determines the outcome. The tax treatment is a detail on top of it, and a great deal of 2017 marketing had that the wrong way round.