September 29th, 2009
Sam Gooch
It is difficult to know where to put your money these days to get the best returns, especially with the way the economy has suffered over recent months, pushing the Bank of England to make a string of cuts to its Base rate which have in turn been passed on to savers rates.
With the Base rate now down to the lowest level ever recorded, rates on normal savings accounts have been slashed, which has limited our saving options.
The two obvious choices in today’s savings market are Fixed Term Bonds, and Individual Savings Accounts (ISA). Although both types of savings accounts have their similarities, there are several advantages and disadvantages to each and it is this topic of discussion that this article will be focussing on.
Fixed Term Bonds
Fixed Term Bonds provide a rate that is fixed throughout the duration of the bond, giving savers a predictable income with no surprises. Once you have chosen a fixed term account, you are able to calculate exactly how much interest you will earn, minus the tax, to give you your end balance.
Most Fixed Term Bonds offer very high deposit limits, generally between £500,000 to £2 million, but some, such as ICICI, will let you invest as much as you like. You must deposit the full amount upon opening the account and cannot add to this once active.
There are no limits to how many fixed term bond accounts you can open within any one year, so unlike ISA accounts, if you decide to close your account for any reason, you can still invest any amount elsewhere at any time.
Fixed Term Bonds generally offer the highest saving rates available, but these tend to be on shorter-term bonds, as they carry less risk to significant rate cuts leading to banks and building societies paying you over the odds in interest for long periods of time.
‘What goes up must come down’
If you are extremely lucky – and do your research, you could open a fixed term bond before rates significantly fall, allowing you to earn well above savings rates offered to new and variable rate customers. If you cast your mind back to October last year, when the Base rate stood at 5%, you would be very happy with yourself if you were earning this kind of rate on your savings today, with the Base rate now at 0.5%.
A big element to a fixed term bond account is the “fixed term”. You must be realistic with your finances and only go for this option if you can afford to lock your money away for some time. If you find that you need to withdraw any amount from your account, the bond will close and in most cases you will lose any interest to accumulated to date.
As well as the possibility of rates falling during the life of your bond, you could see the opposite effect, with rates significantly rising, leaving you locked in at a low rate. It is always a good idea to look at recent trends in Base rate changes to enable you to make an educated prediction on the direction it’s headed. Many economists believe that rates will continue to fall during 2009, going as low as 0%.
Like any normal savings account, you have to pay tax on any interest accumulated, as this counts as income. The general tax rate is 20% for those earning less that £34,800 per annual, and 40% for anything above. There are other conditions to non-earners so check out the HM Revenue for more information.
Individual Savings Accounts
Individual Savings Accounts (ISA’s) offer a tax free alternative to saving. Unlike normal savings accounts, the interest you earn on an ISA is not subject to tax deduction. Every year you are entitled to add up to £3,600 to your ISA, and the interest accumulated from your total balance will be tax free for life. You can deposit up to £3,600 between now and April 2009, which is when your allowance is renewed.
Like many savings accounts, ISA’s offer a variety of options such as instant access, fixed rate, and base rate guarantees.
Unlike a fixed term account, most ISA’s allow you to deposit as many times as you like throughout the year, as long as you stay within your £3,600 annual limit. It is better if you can afford to deposit the full amount at the beginning of the tax year, as this will allow you to earn the maximum possible interest, but for those that would rather have the flexibility to save as they earn, ISA’s are great for making monthly deposits from a salary.
As with fixed term bonds, ISA’s encourage savers to leave their money without making withdrawals. However, rather than deducting the interest earned to date and closing the account, ISA’s simply give savers an annual deposit limit of £3,600, and once this has been reached, no more can be added, regardless of any withdrawals.
Because savers can get good returns from paying no tax on the interest they earn, ISA’s tend to offer lower rates than Fixed Term Bonds.
Most ISA’s are affected by cuts made to the Bank of England Base rate, so if you open an ISA when rates are high, you cannot guarantee they will stay high. Fixed rate ISA’s allow you to fix in at a rate for a specified term, but this does carry some risk, as rates change, especially over a long term.
Always check out what kind of compensation scheme is used by your proposed bank or building society to ensure that your savings are covered in full. For more information on this, see Which4U’s Top Ten Savings Tips.
The bottom line for all savings accounts is to ensure you are earning the highest possible returns on your money. Although ISA’s offer tax free interest, you may find that the difference in rates offered against fixed term bonds will in fact leave you worse off. Before making a choice, compare the savings market for the best deals, and use your new found knowledge of these accounts to make an educated decision on where to invest your savings.
One last thing to remember is to always make sure (where possible) you keep the interest rates paid on your account above the rate of inflation (incuding tax deductions), as anything below would result in your money actually losing value. Inflation is used to measure the rate at which prices will increase, so if this level is higher than the interest you are earning, your money will be slowly eroding.
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