Savings bonds are a good way to make your money work harder, if you can afford to tie up your cash into a bond. They work differently to easy-access savings accounts, as they come with a fixed rate of interest over the set term, or time period. This can be anything from between six months and five years.
Moreover, because you can choose how long you want to keep money in the bond, they allow for better savings because you cannot touch the money until the term is up.
How do savings bonds work?
Unsurprisingly, the longer you commit your money for, the better the interest rate – generally speaking – as the bank or stockbroker can invest your money for longer. And you’ll find that savings bonds typically require a one-off lump sum to open, and with most accounts, you will not be allowed to top up the amount once an account is set up.
This means you will need at least £100 to buy a bond, though many often require a larger initial investment of around £1,000, and in a few cases you can expect to need £5,000 or even £10,000.
Who do savings bonds suit?
Savings bonds work best if you have a definite savings goal – such as a future wedding or for your children’s higher education – because the money is effectively locked away until the term is over.
Bonds are good for long term savings because you know exactly how much you will earn at the end of the term when the account matures. Some savings bonds allow you to be paid any interest earned monthly rather than annually, which is useful if you are trying to top up your monthly income.
...the longer you commit your money for, the higher rate of interest you’ll earn
Personal Savings Allowance
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 2018-19 tax year if your income is less than £45,850*).
If you’re a higher rate taxpayer, paying tax at the 40% rate on an income between £45,351 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 don’t get an allowance.
The fact that your returns will remain the same over time can be a double-edged sword, as while it is often useful for budgeting purposes, if the interest rate increases you could find your account becomes non-competitive.
This is a risk because your account is locked into the fixed-rate, you will not gain more interest should interest rates go up.
Let’s say you’ve gone for a four-year bond which pays 2.75%, for example. It looks like a good deal now, but if interest rates start climbing you may regret the decision. After a couple of years you could be earning 3.50% in an easy access account, but with a fixed-rate bond this won’t change.
Ultimately, the longer you tie up your savings, the greater this risk becomes. But equally, if rates remain low for some time to come, you could end up earning much better returns and if interest rates go down, then you won’t lose money either.
The other potential downside of savings bonds is that you usually can’t get your hands on your cash until the end of the account term without paying a penalty.
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. This means you could be in for a long wait if you’ve put your money into a five-year bond, for instance.
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.
*Different tax rates apply in Scotland, see Gov.uk for details.