The other Isas: Should you invest in a Lifetime, IF or Aim Isa?

Most of us are familiar with three types of Isa: cash, stocks and shares and junior Isas. 

But did you know there are three other types, each with different rules and risks?

One helps the under-40s save for a home; another is for investing in lending firms; and the third is for buying the smallest stock market shares and bagging a potential inheritance tax avoiding benefit.

It isn’t easy to work out whether these alternative Isas are right for you. So here’s a handy guide to help.

Is this right for us? Think carefully about whether a Lifetime Isa will suit your needs

Is this right for us? Think carefully about whether a Lifetime Isa will suit your needs

Lifetime Isa – for a 25% house deposit boost

Launched almost six years ago, a Lifetime Isa can be opened by those aged 18 or over, but under 40. 

You can deposit up to £4,000 each tax year and earn a 25 per cent government bonus up to a maximum of £1,000 a year. 

The £4,000 counts towards your annual £20,000 Isa allowance. You can save into one cash and one stocks and shares Isa alongside the account if you desire.

However, there are strict rules on how you can spend the money you save. 

  • You can use it to buy your first home but this cannot cost more than £450,000
  • Or you can leave the pot untouched until you turn 60 
  • And you can only contribute to it until you’re 50
  • There’s a huge penalty if you break these rules 

Take the money out before age 60 for anything other than a house and you’ll be whacked with a 25 per cent charge. This wipes out the Government bonus and eats into what you’ve saved.

For example, on a £10,000 pot, £8,000 would have come from your own contributions and £2,000 from the Government bonus (assuming no interest or growth). 

A 25 per cent penalty would mean losing £2,500, so the Government bonus plus £500 of your own savings.

A handful of providers offer Lifetime Isas, but none of the big banks do. The best rate is 3.5 per cent from digital firm Moneybox. You can also opt for a stocks and shares version.

VERDICT: The 25 per cent bonus is attractive if you’re saving for your first house. But you must be sure you’ll use it for that – or, alternatively, you can wait until age 60 to access the funds. Otherwise, the penalty is so high that you’re better off using an ordinary Isa or a pension.

Innovative Finance Isa – for peer to peer investing

There is a dedicated Isa for savers who want to put money in so-called peer-to-peer (P2P) lending.

The likes of RateSetter and Funding Circle take savings from customers and lend money to individuals or businesses.

There are some similarities with banks, but P2P firms are more loan match-makers than lenders themselves. And they don’t have the huge overheads a bank has.

The idea is that both savers and borrowers get better rates by cutting out the bank middlemen.

Option: The likes of RateSetter and Funding Circle take savings from customers and lend money to individuals or businesses

Option: The likes of RateSetter and Funding Circle take savings from customers and lend money to individuals or businesses

P2P lending has been around for more than 15 years and you’ve been able to save using a tax-free Isa wrapper since 2016.

However, uptake of Innovative Finance Isas (IF Isas) has been muted. This is partly because P2P lending is riskier than stashing money in a cash Isa. You can lose your capital if a borrower fails to pay or defaults on their loan. Plus, your savings aren’t protected by the Financial Services Compensation Scheme, which covers bank deposits up to £85,000.

Some firms offer as much as 9 per cent returns, but beware, the higher the risk, the higher the rate.

Some IF Isa providers have gone bust in the past. And industry leader Zopa pulled out of peer-to-peer lending altogether at the end of 2021 to focus on banking.

VERDICT: Do your homework if you’re tempted. Treat this like an investment where there’s a risk you could lose all your capital. Best for more experienced investors who are happy to experiment with a slice of their portfolio. 

Aim Isa – for IHT planning

This is a specialist Isa that can hold only stocks listed on the Alternative Investment Market (Aim). 

Often referred to as Britain’s ‘junior’ stock market, Aim is home to thousands of fast growing technology, healthcare and environmental companies.

Success stories include the tonic maker Fever-Tree, package holiday seller Jet2 and video games support company Keywords Studios, each now worth more than £1billion.

This is essentially a twist on the standard stocks and shares Isa and you get the same rules on the £20,000 tax-free Isa allowance and benefits of tax-free income and growth, but qualifying Aim stocks back an inheritance tax break.

After two years of holding the shares, you should be able to pass them on without incurring inheritance tax (IHT). 

The trade-off is that Aim-listed companies are risky, with no guarantee of success; many fail.

But if you’re using Aim Isas for tax planning, the value of the portfolio will need to fall 40 per cent more than other investments to cancel out the IHT benefits.

You can choose your own stocks or a ready-made selection run by an Aim Isa specialist such as Octopus, via a financial adviser or broker such as Wealth Club.

Beware, not all Aim companies qualify for the IHT-free benefits. 

VERDICT: For sophisticated investors only. Speak to a financial adviser to work out whether this type of account fits your needs.

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source: dailymail.co.uk