What are savings bonds?
Savings bonds are a collection of financial products which work like savings accounts – you deposit a certain amount of money with a bank, a building society or the government, and you receive period interest on that money.
Bonds work slightly differently to other types of savings: they require you to lock your money up for a set period, and they often ask for a minimum deposit. In effect, they’re a fixed-term loan you offer to the provider in exchange for a known return on your investment.
Bonds generally last between six months and five years, and the longer you lock your money away, the better the rates you’ll get – but you’re powerless if interest rises.
How do savings bonds work?
Unsurprisingly, the longer you commit your money for, the better the interest rate – generally speaking – as your bank or stockbroker can invest the money for longer.
Savings bonds typically require a one-off lump sum to open, though in most cases you will not be allowed to top this amount up once your account is set up and the typical 14-day grace period has passed.
You can usually get access to your money if you write to the provider and ask for it to be released, but this will close the account and you won’t be able to collect the full amount of interest that has accrued. It’s wise to read the terms and conditions before you open an account.
While a few bonds can be opened with a minimum of £1, you normally need at least £100, though many often require a larger initial investment of £1,000. In a few cases you can expect to need £5,000 or even £10,000.
Are savings bonds right for me?
Savings bonds can be quite lucrative to the right person – but they won’t work for everyone, even though you tend to get better interest rates than with other savings accounts.
They 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 will suit people who can afford to lock away a portion of their money. They’re less certain if you’ve had cash flow issues in the past, or if you’re in insecure employment – you might want to consider an easy-access savings account or a cash ISA instead, to give you more flexibility to access money in an emergency.
If you need more help deciding, the MoneySuperMarket savings decision tree might come in helpful.
How to choose the right fixed-rate bond
As you can see, there are several factors to consider when picking the bond that’s right for you. When looking at each one, think about the following:
- Do you have enough to meet the minimum deposit, and can you afford to lock that money away for a long time?
- How readily will you need access to your money, and how long can you afford to lock it up for?
- Which interest rates are available – obviously the higher you can get, the better
What are National Savings and Investments (NS&I) bonds?
The UK government offers a few bond options:
- NS&I income bonds: Income bonds are variable-rate savings products with an attractive rate of interest. The government can – and does – change the rate of interest, but it tends to be solid. You need a minimum of £500 to open account, but you can withdraw money in increments of £500 with no notice and at no penalty to your interest. Interest is also calculated daily, so it grows slightly faster than most other accounts
- NS&I premium bonds: Premium bonds are a very different product. Effectively a lottery, you are entered into a prize draw every month for every premium bond you own. Monthly prizes range from £1 to a jackpot of a £1m, but the odds work out to an annual average return of 1.4%. Because it is a prize draw, however, you might get a much better return one month, or you might win nothing at all. All winnings are tax free, and you can’t lose money – though you’re obviously not guaranteed to make any either
What is the personal savings allowance?
Interest is considered income for the purposes of calculating income tax. This means that provided you’re earning more than the minimum threshold – which was £12,500 a year in the 2020/21 tax year – you have to pay tax on your interest.
However, the personal savings allowance allows you to avoid paying tax if you earn under a certain amount in interest.
- Basic-rate taxpayers, who earn between £12,500 and £50,000 per year, won’t be taxed on their first £1,000 of interest
- Higher-rate taxpayers, who earn between £50,001 and £150,000, do not have to pay tax on their first £500 of interest
- Top-rate taxpayers, earning £150,001 and above, must pay income tax on all their interest tax earnings
These levels are subject to change every tax year as the income tax thresholds change.
The risks of fixed-rate savings
The fact that returns on fixed-rate bonds cannot change over time is a double-edged sword: you might settle on an attractive rate, but if the interest rate increases you could find that your account becomes non-competitive.
Let’s say you’ve gone for a four-year bond which pays 1.2%. It looks like a good deal now, but if interest rates start climbing you may regret the decision. If after a couple of years there are easy-access accounts on the market offering 2.5%, your fixed-rate bond is actually costing you money.
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 remember that you won’t lose money if interest rates go down.
The other 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.
Compare fixed-rate savings bonds
You can compare fixed-rate savings bonds with MoneySuperMarket. We work with a range of partners to offer accounts with attractive rates of return.