Unlike easy access accounts, a savings bond comes with a set term and a fixed rate of interest during that term. You can choose how long you want to tie up your cash for as bonds tend to require you to tie up your money from between six months and five years.
How do savings bonds work?
As you may expect, as a general rule, the longer you commit your money for, the higher rate of interest you’ll earn. Savings bonds usually require you to invest a one-off lump sum, and most accounts won’t allow you to top them up once they are up and running. As a result, you’ll usually need at least £100 to open this kind of account, although many require a £1,000 initial investment or, in a few cases, as much as £5,000 or £10,000.
Who do savings bonds suit?
A savings bond might be right for you if you’ve got a defined savings goal in mind. Perhaps you’re saving towards a wedding in a couple of years’ time, or you want to get on the property ladder in the next few years?
As you know exactly how much interest you’re going to be earning with a savings bond, you know what you’ll end up with when the account matures. Some savings bonds allow you to have the interest you earn paid monthly rather than annually – which can be useful if you’re looking to top up your existing income.
Thanks to the introduction of the Personal Savings Allowance in April 2016, all basic rate taxpayers can now earn £1,000 of savings interest a year without having to pay any tax on it. You’re a basic rate taxpayer in the 2017-18 tax year if your income is less than £43,000).
If you’re a higher rate taxpayer, paying tax at the 40% rate on an income between £43,001 and £150,000, you’re entitled to a lower PSA of £500 a year.
If you’re an additional taxpayer earning £150,001 or more, you won’t get an allowance at all.
...the longer you commit your money for, the higher rate of interest you’ll earn
Knowing your returns will remain the same over time may be useful for budgeting purposes, but it can also be something of a double-edged sword.
After all, the last thing you want is for interest rates to rise, while you have locked yourself into an account that is no longer competitive.
Let’s say you’ve gone for a four-year bond which pays 2.75%. It looks like a good deal now, but what if interest rates start climbing and, after a couple of years you could be earning 3.50% in an easy access account? The longer you tie up your savings, the greater this risk becomes.
On the flipside though, if rates remain low for some time to come, you could end up earning much better returns than if you had plumped for an easy access savings account.
The other potential downside of savings bonds is that you cannot usually get your hands on your cash until the end of the account term. A few savings bonds allow a limited number of penalty-free withdrawals, but most charge a penalty – in the form of loss of interest – if you want to take out any money before the bond matures. That means you could be in for a very long wait if you’ve put your money into a five-year bond.
Where can I find savings bonds?
Savings bonds are offered by wide range of providers including high street banks, building societies and even supermarkets. If you decide a fixed rate savings bond, is right for you, remember rates vary so be sure to shop around for the best deal.