Savings Guide

Savings bonds - a basic guide

Updated: Thursday 2 June, 2011

By Madeline Thomas - editorial@consumerchoices.co.uk

Banks and building societies are offering enticing savings bonds with headline-grabbing rates. But what are the downsides?

The Bank of England base rate is at an all-time low of 0.5%, yet banks and building societies are offering apparently attractive savings bonds with headline-grabbing rates.

They are doing this because financial institutions still need good quality deposits to allow them to make money by lending.

In the wake of the nationalisation of Northern Rock and part-nationalisation of RBS, the Financial Services Authority (FSA) tightened the rules on the proportion of quality savings compared to loans that financial institutions need to have on their books.

So, in order to entice savers over the threshold, they’re offering some great deals.

• What are savings bonds?
• How good are savings bonds rates?
• How safe are your savings bonds?
• Savings bonds - recommendations

What are savings bonds?

Savings bonds offer the highest rates in the savings market, so they tend to grab the biggest headlines.

They can do this for two reasons: firstly, rates are fixed, so the banks know the maximum they will ever pay out. Secondly, savers have to lock their money away for a specific number of years to get the rates, so the banks enjoy the certainty of knowing how long they hold the cash for.

Savings bonds are offered in “issues”. Banks allocate a lump of money (the funds which the public invests) against what the markets believe will happen to interest rates over a fixed period. They then earn the difference between what they make on the markets and what they offer to consumers.

That is how the rate is priced. Once that bank has received sufficient funds from consumers to cover its investment, that particular “issue” or “tranche” is closed.

This explains why some bond offers are around for a long time and others seemingly disappear overnight.

Although this tends to only occur with smaller providers such as local building societies, there are examples of attractive savings bond deals being issued on a Friday, hitting the best buy tables in the newspapers at the weekend and then closing on the Monday after investors have piled in with their money.

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How good are savings bonds rates?

Savings bonds rates of around 3.5% are not unusual at the moment.

Savers earn more for locking their money out of reach for a set period of time. They are being paid both for the inconvenience and for the fact that, should base rates rise while their money is still locked away, their rate may no longer be competitive.

In the market at the moment it’s possible to find bonds paying up to 5%, but you must invest your cash for five years.

However, locking funds away for five years could prove costly, particularly when base rates - at 0.5% - can realistically only go higher, pushing savings rates up with them.

The danger is that, in four or five years’ time, a rate of 5% may not be so attractive.

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How safe are your savings bonds?

People who invest in savings bonds are those who are approaching retirement or already retired and who have lump sums to invest as these are not accounts in which savers can drip feed regular payments.

That brings another issue into play - should that bank get into financial difficulties, how secure are savings bonds?

The good news is that investments in institutions registered with the Financial Services Authority are covered under the Financial Services Compensation Scheme (FSCS) up to the value of £85,000.

Bear in mind though that this “allowance” is per person, per FSA-authorised institution, regardless of the number of separate accounts a person may hold with that institution.

So, if your bank turns into another Northern Rock and you have £85,000 tucked away in a two-year bond, you will get your money back.

However, that £85,000 limit covers the financial group as a whole, not the individual companies within it. The notable exception is Lloyds Banking Group, as Lloyds TSB, and HBOS are considered separately under the FSCS as they have separate banking licences.

As the £85,000 limit includes all assets in all accounts in all brands of a single banking group, it’s imperative to check which financial organisations are grouped together under this scheme. Here is an at-a-glance guide:

• HBOS - Bank of Scotland, Birmingham Midshires, the AA, Saga, Halifax, Intelligent Finance, Capital Bank
• HSBC, First Direct, Marks & Spencer Financial Services
• Skipton Building Society, Scarborough Building Society (BS), Chesham Building Society
• Royal Bank of Scotland, Direct Line, , Nat West, The One Account, Direct Line (savings only), Coutts
• Santander, Cahoot, Alliance & Leicester
• Bank of Ireland, Post Office Savings (the products are provided by BoI UK)
• Lloyds TSB, Cheltenham & Gloucester
• Nationwide Building Society, Cheshire BS, Dunfermline BS, Derbyshire BS
• Clydesdale Bank plc, Yorkshire Bank (both are UK divisions of National Australia Group)
• Co-operative Bank, Britannia BS, smile (online bank)

If you have more than £85,000 to invest, make sure you split it into accounts from different banking groups to keep it safe.

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Savings bonds - recommendations

In summary, if you have money to lock away, make sure the rate is at the top of the best buy tables. In an era when interest rates can only go up, don’t lock your money away for too long and don’t exceed the £85,000 limit in any of the groups listed above.