What are savings bonds?

Key takeaways

• Once you have deposited an initial lump sum, you receive a fixed interest rate over the bond’s term (ranging from six months to five years)

• Ensure you won’t need the funds during the bond’s term to avoid penalties

• Personal savings allowance may exempt interest from tax based on income tax rate

• NS&I offers income bonds and premium bonds (lottery-style) with tax-free prize draws

What is a savings bond?

Savings bonds are akin to a financial time capsule, allowing you to tuck away your money for a set period in exchange for a fixed return. They're a type of savings account that requires an initial lump sum deposit—often starting at £500 or £1,000—and in return, you're guaranteed a certain rate of interest over the bond's term, which can range from six months to five years. The longer the term, the sweeter the potential returns, but this comes with a trade-off: your money is out of reach for the duration of the bond, and you might miss out on higher interest rates if they rise during this time.

How savings bonds work

Savings bonds are straightforward yet disciplined financial instruments. Here's what you need to know:

• The initial deposit can be modest or substantial, with some bonds requiring as little as £1, while others may ask for £1,000.

• Once you've made your initial deposit, that's it—additional deposits are typically not on the table.

• The interest rate is fixed, which means you'll earn a consistent amount throughout the bond's term.

• Thinking of dipping into your bond early? Be prepared for penalties, which can include charges or a loss of interest.

• When the term concludes, you can collect your funds and the interest they've earned, or you might choose to reinvest in another bond. Always read the fine print to understand the terms and conditions fully.

Types of savings bonds

Savings bonds come in various flavours, each with its unique characteristics:

• Fixed Rate Savings Bonds: These offer a guaranteed return over the bond's term.

• Tracker Bonds: Their interest rates follow an index, like the Bank of England base rate, potentially earning you more than a standard savings account.

• Income Bonds: These pay interest regularly and often allow you to withdraw the principal without penalty.

• Government Bonds: Offered through National Savings & Investments, these are backed by the HM Treasury.

• Premium Bonds: Instead of interest, you're entered into monthly prize draws with the chance to win up to £1 million.

• Green Bonds: These offer a fixed return and support environmentally friendly projects, sometimes with tax incentives.

Choosing the right bond term

The most common lengths of bonds are one, two, three and five years, but you might be able to find both shorter and longer terms. The key is to ensure that you won't need the funds during the bond's term to avoid penalties.

Savings bonds vs. stock market

When it comes to the potential for higher returns, the stock market often comes to mind. However, it's a more volatile option compared to the predictable nature of fixed-rate bonds. While the stock market may offer better long-term gains, it comes with a risk that isn't present with savings bonds, which provide a known return at the end of the term.

Pros and cons of savings bonds

Savings bonds have their advantages and drawbacks:

Pros:

• Higher interest rates compared to regular savings accounts.

• Fixed-rate bonds guarantee your returns.

• Your original capital is not at risk and will be returned with interest.

• If market interest rates fall, your locked-in rate becomes even more attractive.

Cons:

• If market rates rise, your fixed rate might lose its luster.

• Your cash is tied up for the term, which could be inconvenient in emergencies.

• Early withdrawal penalties can take a bite out of your interest.

Tax implications

Thanks to the personal savings allowance, you may not have to pay any tax on your savings bond. This allowance lets you earn interest up to a certain limit tax-free, depending on your income tax rate.

National Savings and investments bonds

The UK government offers a few bond options through its National Savings brand, including variable-rate NS&I income bonds and NS&I premium bonds, which are a lottery-style bond with tax-free monthly prize draws.

Are savings bonds right for you?

Saving bonds typically suit people who can afford to lock away a portion of their money for a fixed time. They might be less attractive to those who have had cash flow issues in the past, or if you’re in insecure employment – in this case, 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 could be helpful.

Other useful guides

• Guide to NS&I

• High interest savings accounts guide

• How safe are your savings?

Compare savings accounts with MoneySuperMarket

With MoneySuperMarket you can see interest rates, deposit requirements, and terms at a glance. Filters streamline your search, and once you've made your choice, you can apply online directly with the provider.