If you have money available, that you don’t need for living expenses, putting it to work earning interest is usually a shrewd move. It ensures your money is held safely, it helps protect the value of your cash from being eroded by inflation, and it can reduce the urge to spend unnecessarily. But, with so many savings account options in the UK, how do you ensure you get the best return?
You could place your money in a standard easy-access account, but the interest available from those products remains very low. You could opt for a peer-to-peer investment product that offers seemingly high returns – but with no statutory deposit protection, you could be compromising the security of your investment. Or, if you’re willing to forgo the use of your money for a set period, you could enjoy better interest rates and excellent deposit protection with a fixed rate bond (aka fixed rate savings account)
Fixed rate bonds are a type of savings account that offer higher rates of interest compared to easy-access products, but you must be prepared to lock your money away for a fixed period of time – usually one to five years.
The main advantage of fixed rate bonds is that they tend to offer better interest rates than other protected savings products. However, they also offer another benefit which is often overlooked.
Most easy-access and ISA savings products offer variable rate savings. That is, the rate of interest they pay can change at the providers’ discretion. Obviously, this can’t be applied retrospectively, but it can mean that, unless you keep a close eye on your account and switch when necessary, the interest you are paid might be considerably lower than the rate you originally applied for. This is not the case with fixed rate bonds, where the interest rate is fixed in advance, so you’ll know before you invest exactly what your return will be.
Many fixed rate savings accounts are available from banks (and other institutions) which are protected by the Financial Service Compensation Scheme (FSCS). The FSCS protects up to £85,000 of your savings at each institution, giving you confidence that you will get your money back if a bank fails.
Because the protection that the FSCS offers is per institution, it makes sense to split sums which exceed £85,000 between different banking groups (not brands) to gain protection for all your savings. Bear in mind that you should leave room for interest growth: if you placed £85,000 in a bond at 2.5% for three years, you would earn £96,305.10, but only £85,000 would be protected. You’d forfeit your interest if the bank failed. Instead, if you’d only deposited £75,000, your entire investment with interest added annually would be covered.
It goes without saying that the FSCS will not pay out interest you haven’t yet earned, but if the interest has been added to your balance, it should be protected.
The main drawback of fixed-rate products is that you can’t withdraw your money without incurring penalties. So, if you discover you need your money, or you find a more attractive savings account, your options are limited. For this reason, fixed rate bonds are only suitable if you can afford to forgo their money for the required period – perhaps by not placing all of your available funds within a fixed rate product.
Another disadvantage of fixed rate bonds is that the type of product isn’t regulated, so different types of organisations – not just banks – can offer fixed rate bonds. While the fundamentals of the products are all same, some of these organisations offer deposit protection, while others don’t. If you choose to invest in an organisation which does not offer FSCS protection and it fails, you could lose all your money – so check for the FSCS logo before applying if you want maximum possible protection.
You will usually have to lock your money up in a fixed rate bond for between one and five years, depending on the product.
Usually, the longer the bond duration, the higher interest rate – but that isn’t always the case. Even where that is the case, there’s a judgement to be made: is the increased interest rate worth forfeiting control of your money for another year or two? Unfortunately, the right answer is only ever available in hindsight, so you’ll need to decide what is right for you in the here and now.
Yes, all savings are taxable if the interest they generate exceeds your annual tax allowance plus your personal savings allowance. However, fixed-rate bonds can make your tax calculations a bit confusing. HMRC taxes interest when it becomes available to you to withdraw. So, if you earn £1,000 per year in interest from a bond and it is paid annually into another account that you have access to, you might be within your personal savings allowance and pay no tax. However, if the fixed-rate bond pays out all of the interest upon maturity at the end of the term, and the interest exceeds £1,000, you will probably be taxed.
While fixed rate bonds are an attractive savings product, you can often get better interest rates, FSCS protection, and sometimes a switching incentive with some current accounts. Obviously, this requires you to switch your bank account, which isn’t for everyone. Your money will also be freely available, so there’s a greater risk that you’ll be tempted to spend it, and interest on these accounts tends to be limited to a fixed amount, so they aren’t necessarily the best vehicle for saving larger sums. However, if you’re only depositing a small sum, current accounts can offer the most generous and safe returns.