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Fixed rate bonds

sebastian-anthony
Written by Sebastian Anthony

Fixed rate bonds are savings accounts which tend to pay a higher rate of interest than easy access savings accounts. They are also known as ‘fixed rate savings accounts’ and allow you to put a lump sum of money away for a set period of time, usually between 1 and 5 years.

Interest rates right now are low across the board because of the coronavirus pandemic but you may be able to find a higher rate with a fixed rate bond, rather than an easy access savings account. This is because you're essentially being paid in interest to lock your money away.

What are fixed rate bonds?  

Fixed rate bonds are savings accounts but they require you to lock your money away for a fixed period of time. 

If you pick a fixed rate bond you’ll need to read the terms and conditions carefully first as many providers do not allow cash withdrawals before the fixed term ends. Some do, but will charge you for the privilege, either in the form of fees or as a reduction in your interest rate.

You can apply for most fixed rate bonds online, over the phone, by post, or in a branch. Check with each provider before you apply.

Is a fixed rate bond right for me? 

If you’re looking to open a savings account, and you’re wondering if a fixed rate bond is the right kind, the following pros and cons should help you decide.

Pros of fixed rate bonds  

  • They’re a good way to build up interest if you have a lump sum of cash you do not need access to for a fixed period of time

  • You’ll know exactly how much interest you'll earn and when it will be paid to you

Cons of fixed rate bonds  

  • You may not be able to access your funds without penalty during the term of the bond

  • If you do take your money out early, the fees or the loss of interest you'll incur from early access may wipe out any return on the initial investment 

  • If interest rates increase before the end of the fixed term you may lose out 

What is happening to interest rates?

Thanks to the historically low Bank of England (BoE) base rate, all interest rates remain low in the UK today as a result of the coronavirus pandemic. This means even the best fixed rate bonds aren’t paying huge amounts of interest, but this may be more than the interest being paid elsewhere. 

However, it’s also worth remembering that if the BoE increases the base rate, all other interest rates will also rise. If rates go up while your money is locked away in a 5 year bond, for example, you would not be able to take advantage of the better rates.

How to pick a fixed rate bond  

To find the best account for you, you’ll need to compare fixed rate bonds from a few different providers. There is more to consider with a fixed rate bond than the time your money is locked away for including the following:

  1. How much you need to deposit to open the account  

  2. When you need to deposit money to start earning interest on it

  3. How often the interest is paid

  4. How much money is protected in case an institution goes bust

  5. Any tax you may have to pay

Here we’ve looked at each of these points in a little more detail

What are the minimum and maximum deposits on a fixed rate bond? 

There's almost always a minimum and/or maximum deposit amount when you open a fixed rate bond. You’ll be told this before you open the account and you'll not get the highest interest rate available unless you deposit the minimum amount.

There may also be a maximum balance limit. This varies quite a bit but if you have a large sum of money to put away it’s worth finding out what the limit is first.   

When do you need to make a deposit into a fixed rate account?

Every account will differ but in some cases you'll need to make the first deposit within a few days of opening the account.

Some accounts do offer a small window of time where you can make several deposits but these will also have a final deposit deadline. After that, the account will usually be closed for deposits and your interest calculated on the balance in the account at that time.

Therefore, to receive the interest you expect, it’s important to deposit the money you're planning to invest in good time.

If the deposit time has ended and you have another lump sum to deposit, you'd usually need to open a second account. You may be able to open it with the same provider, but it cannot exceed the maximum balance limit.

How often is interest paid with a fixed rate bond? 

You may be able to choose how often the interest is paid, although it all depends on the account and the provider.

Depending on how long the fixed rate lasts for, you could also end up earning interest on your interest, which is known as compound interest.

If you opt for monthly rather than annual payments, there may be a slight reduction in the interest rate. This is because you'd be earning more compound interest, and the bank or building society needs to balance the scales.

How much of your money is protected?

The Financial Services Compensation Service (FSCS) protects funds up to £85,000 in accounts (or £170,000 in joint accounts) per banking group. What this means is, if your provider falls into bankruptcy, the FSCS will reimburse you up to £85,000.

If you have more than this amount to invest in a fixed rate bond, spread your money across a few accounts. Each account needs to be with a different banking group because the maximum reimbursement per group is £85,000. Always check to ensure your savings accounts are not all with the same group.

Not all suppliers have FSCS protection. Some use alternative schemes backed by other European Governments, like the French Fonds de Garantie des Dépôts et de Résolution. Your level of protection can fluctuate on a daily basis, in line with foreign exchange rates.

Other suppliers offer their own protection schemes, and some may offer no protection whatsoever which means you could lose all your savings should the provider go bust.

Unfortunately, suppliers with no protection often offer some of the best interest rates. This makes them very tempting and highlights the importance of looking beyond rates when you're shopping around.

How much tax will you pay with a fixed rate bond? 

Your tax bracket influences how much you can save tax-free. Basic rate taxpayers, paying 20% tax, can earn £1,000 interest without paying tax. While high rate taxpayers, paying 40% tax, can earn £500 interest tax-free. All savings account interest is paid gross.

If the interest you earn exceeds those thresholds, you'll need to declare it on your tax return.

Fixed rate bonds FAQs

Ultimately the best fixed rate bond for you will depend on your financial circumstances and savings goals.  For some people, putting a lump sum away for four years may be the best option if they’re happy not having access to it. While others may prefer a shorter term account which allows them to access the money earlier but also to move the money, when interest rates do begin to rise again.  

How many fixed rate bonds can you have?

There’s no limit to the amount of fixed rate bonds you can have and in order to make your money work for you, it’s worth spreading it between a few different accounts if you have lots of savings.

For those with savings above £85,000, also be sure to spread your money across different banking groups. That way you're eligible for the most amount of protection from the FSCS.

Should I take money out of a fixed rate bond early? 

It may not be worth withdrawing your money before your bond matures even though some providers do allow for early access to your money in a fixed rate bond. This is because there's often a penalty for this. Early access penalties tend to mean forfeiting at least one year’s interest.

If you want to withdraw your money within the first year of the bond, the penalty charge could be deducted from the original investment. 

Can you open a joint fixed rate bond? 

Several suppliers offer bonds that can be held in joint names, though this is often capped at two people.

The FSCS protection stretches to £170,000 per banking group on joint fixed rate bonds.

What happens if you die before the end of a fixed rate bond? 

If you die before a fixed rate bond has matured, it may not be possible to withdraw these funds and put them towards your estate.

This depends on the provider of the bond. Some allow accounts to be closed early, so the money can be released to your estate while others may insist that your money is only released to your executor when the bond matures.

For joint fixed rate bonds, the bond will continue until maturity in the name of the surviving bondholder.

Choosing a savings account

16th November 2020