For most of the last 20 years savers looking for a home for their annual Isa allowance simply chose between risky shares and safety-first cash.
But with the rates on cash accounts stubbornly low (1.5 per cent at best) and stock markets looking uncertain, many are feeling that they are stuck between a rock and a hard place.
Since 2016 there has been a third option – the ‘innovative finance’ Isa – that can help savers diversify their Isa portfolio and potentially solve a dilemma for those fearful of equities and disgruntled with cash returns.
The ‘innovative finance’ Isa is where savers invest their money via a peer-to-peer platform
The innovative finance option is where savers invest their money via a peer-to-peer platform. In turn, the platform lends their money to others – either individuals who perhaps want to pay for a new car, holiday or home improvements, or to businesses needing cash to expand their operations or purchase equipment.
The platform charges the borrowers interest and after taking a cut pays a return to the lender – usually paying rates at least three or four times the level paid on traditional cash accounts.
By holding the investment in an Isa, returns are tax free.
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HOW THIS IS MONEY CAN HELP
How to choose the best (and cheapest) DIY investing Isa – and our pick of the platforms
Peer-to-peer investments are not risk free as the borrowers can – and do – default. There is the potential to lose all of your investment.
But to reduce the risk for investors, lending platforms spread money among many borrowers so that investors are not dependent on the financial strength or weakness of a single borrower.
This third way is gaining traction with nearly £3billion lent through platforms last year.
Tread carefully at the start
Before taking the leap consider the following:
1. Invest only a small sum to start with to ensure you are happy with how the platform works.
2. Check the provider’s website for details of the measures they take to protect your money. Most offer some form of safety net.
3. Look at their track record on defaults and losses. RateSetter, for example, gives full details of its safety net fund.
4. Find out if you can get at your money in an emergency – and whether exit charges are applied.
About £290million of this was invested via innovative finance Isas in the last tax year – an eightfold increase on the sums invested in the tax year before. But this all pales into insignificance compared to £40billion put in cash and £29billion in stocks and shares Isas.
One of the most well-established platforms is Zopa. Launched 14 years ago, it lends money to low-risk individual borrowers. Zopa has target rates of return of between 4.5 and 5.2 per cent. Other big players include RateSetter and Funding Circle. Andrew Lawson, from Zopa, says: ‘The innovative Isa represents an excellent middle ground for investors put off by increasingly turbulent equity markets or disappointed by pitiful returns from cash Isas.’
Other styles of peer-to-peer investments allow investors to lend their cash to specific types of project. For example, platform Relendex issues loans to commercial and residential building projects, while an innovative finance Isa from Oaksmore directs lenders’ money towards property restoration. Abundance Investing gives access to renewable energy projects.
Investors who want to spread their risks across different platforms in a single Isa can consider buying their Isa through an aggregator providing access to several peer-to-peer providers.
Orca Money has just launched, offering access to Isas across five platforms – Lending Works, Assetz Capital, Landbay, Octopus Choice and Lending Crowd. Investments start from £100 and provide a return of up to 5.3 per cent a year.
Iain Niblock, chief executive, says: ‘Investors’ funds are automatically spread across some of the country’s leading peer-to-peer platforms. This spreads the investment across a broad range of asset classes and risks.
Investors can choose from two portfolios – Orca Pure aiming for a 4.3 per cent annual return and Orca Plus (5.3 per cent).
Mario Lupori, of RateSetter, believes his company’s platform also provides diversification. He says: ‘Our platform has the advantage of automatically diversifying every investor’s risk across all our £850million worth of active loans – resulting in steady returns averaging 4.4 per cent a year. Investors’ money is spread across more than 250,000 loans, no matter how much they have invested. You get the same level of risk if you invest £10 as you do £100,000.’
Savers can only contribute to one innovative Isa from a single provider each tax year, though they can switch existing Isas into one.
Andrew Hagger, of financial consultancy Moneycomms, says: ‘I would only recommend peer-to-peer as part of a wider portfolio. You need to do your homework and understand how your money will be used, the expected level of bad debts, and how you can get your money back if needed. Do not be lured in simply because of the attractive advertised return.’
He adds: ‘I’ve invested in a number of peer-to-peer schemes and to date have not lost any money. But there have been occasions when repayment has been later than originally agreed.’
Make the most of your annual Isa allowance
Everyone age 18 or over has an annual allowance of up to £20,000. It is a case of use it or lose it by April 5, 2019, as unused allowances cannot be carried over. In terms of using it, either put up to £20,000 in cash, stocks and shares, or an innovative finance Isa. Or split the £20,000 between the types you prefer.Don’t forget the kids. Anyone aged 16 or over can open a cash Isa with the maximum £20,000. Children of all ages can also have a Junior Isa – where parents can salt away £4,260 on their behalf.Youngsters aged 16 to 18 can open a cash Isa and a Junior Isa in the same tax year, meaning for two years they can shelter up to £24,260 a year tax-free. Savers can also opt for a lifetime Isa to help buy their first home or save for later life. You must be 18 or over but under 40 to open one. The limit is £4,000 each year until age 50. The Government will add a 25 per cent bonus to the savings, up to a maximum of £1,000 per year. The £4,000 counts towards the £20,000 Isa allowance. From age 50 you can no longer pay into the lifetime Isa or earn the bonus.