Low-risk alternatives to pensioner bonds

The hugely popular NS&I 65+ Guaranteed Growth Bonds are paying 2.8 per cent for one year and 4 per cent for three years to those aged over 65 and were snapped up by pensioners spotting a rare opportunity for high-yielding investments. Their withdrawal from the market has left savers hunting around for similarly safe investments offering high returns. But where can you find that holy grail of low risk and decent income?

Cash alternatives

The closest thing to the pensioner bonds is a fixed-rate savings bond or account, where you agree to tie up your money for a fixed period in order to receive a higher fixed rate of interest over that period.

Many fixed-rate bonds will not allow you to withdraw your money before the time limit is up and some charge you for doing so. Saga, for example, charges customers to withdraw funds from its two-year fixed-rate savings account, equivalent to 90 days of tax-free interest taken from your account balance.

Risks include inflation

For the highest interest rates you need to lock your money away for five years or more. United Bank offers 3 per cent AER on its five-year fixed-rate deposit access account (minimum deposit: £2,000). Secure Trust Bank offers a 3.11 per cent AER on its seven-year fixed rate bond (minimum deposit: £1,000).

However, locking up your money for such long periods is risky. You face losing flexibility and access to your money, which you might need. There is also potential for a once-appealing rate to seem far less so in the event of a rise in inflation and hike in interest rates.

With the UK slipping into negative inflation last week, that risk might seem remote, but don't be fooled. Chris Williams, CEO of Wealth Horizon, says: "The UK is now officially experiencing deflation for the first time since March 1960 when prices fell by 0.6 per cent year on year. While prolonged deflation is dangerous, the UK is almost certainly going to see the return of inflation in the next few months as the dramatic fall in the oil price and the impact of a vicious supermarket price war fall out of the equation."

You might be better off sticking to a one- to three-year time period when it comes to tying up your cash in fixed-rate deposit accounts. For longer time horizons it could be worth opting for funds and investments, where you stand a chance of earning higher income, although take more risk.

Colin Low, managing director of Kingsfleet Wealth, says: “If you're looking to put money away for five to seven years then cash is unlikely to be the best place. But conversely, if someone wants to have access to capital in the next two to three years you shouldn't be looking at anything other than cash.”

Danny Cox, chartered financial planner at Hargreaves Lansdown, says: "People need to make sure they're not holding too much cash and look to equities or other risk-based assets to give higher returns."

But Investors Chronicle's economist Chris Dillow points out that cash will always remain a vital portfolio diversifier, regardless of where rates move. Don't forget that the cash element of your portfolio acts as an insurance policy as well as a source of returns.

The best rates

Punjab National Bank offers the top one-year fixed rate of 2 per cent with a minimum investment of £1,000 and a 2.55 per cent rate on a three-year bond. However, the bonds are available only to those who hold or open a current or savings account with the bank.

First Save also offers a rate of 1.9 per cent fixed for one year and pays interest monthly. Paragon Bank offers the top two-year fixed account, offering 2.21 per cent AER, while United Bank's two-year fixed-term deposit comes with a 2.15 per cent AER and a £2,000 investment.

When placing your savings with overseas banks that have a UK presence or smaller UK players, make sure that you are comfortable with the credit rating of the bank and check out that they are registered with the Financial Conduct Authority and covered by the Financial Services Compensation Scheme, which guarantees deposits up to £85,000. The banks that we mention in this article have FSCS protection.

Alternatives - Cash Isas

Top fixed-rate cash individual savings accounts (Isas) (for those who haven't used their annual Isa allowance of £15,240) include Santander, which pays 2 per cent AER for a two-year fix for 123 current account and credit card customers. Kent Reliance and Aldermore Bank also pay 1.85 per cent AER for the same time period. Mr Cox says: “With a cash Isa you are sheltering your money from the tax man and building up your very own tax safe haven. And once it is locked away, the tax benefits are cumulative."

Buying a state pension top-up

Retired investors looking to boost their income could take part in a new government scheme - state pension top-ups. The scheme was announced in the Autumn Statement 2013, when the chancellor said pensioners would be able to top up their state pension with a new class of voluntary national insurance contribution - Class 3A. It means that anybody reaching state pension age by April 2016 will be able to pay a lump sum in order to receive additional state pension. All those qualifying will have 18 months from 12 October 2015 to 1 April 2017 to take advantage of the scheme.

It is designed to benefit pensioners who have not accued enough years of National Insurance contributions in order to qualify for the full state pension. It is also aimed at those unable to qualify for the new, higher, flat-rate pension which will be introduced from 2016.

Under the scheme, those over 65 will be able to buy £1 extra state pension per week for a lump sum of £890, adding up to £52 per year for life. To take home an extra £260 per year they will have to pay £4,450 and to buy the maximum £25 extra per week costs £22,250. The rates are lower for older age groups, with an extra £1 per week costing those 70 and over £779 and those 75 and over £674.

To get a real benefit from the scheme, you need to earn all your lump sum capital investment back as income and then accrue an additional return over that. For a 65-year old paying the full amount, it would take 17 years to earn back the lump sum investment. A 70-year-old receiving the full £25 per week extra would be 85 years old before the investment was repaid. Note these figures don't account for taxes or inflation.

www.gov.uk/state-pension-topup

Best rates for fixed-rate bonds and accounts

*Need to have an account with the bank

**This is an expected profit rate so not guaranteed. Also sharia compliant account so you cannot take interest 

Source: Investors Chronicle, using provider websites on 19 May 2015