Join our community of smart investors

Paying the penalty for better rates

Taking out a five-year NS&I Guaranteed Growth Bond and paying the penalty to cash it in early could be better than investing in a shorter-term one.
January 21, 2016

One-year National Savings and Investments (NS&I) 65+ Guaranteed Growth Bonds, commonly referred to as pensioner bonds, started to mature last Friday. More of the one-year versions of these bonds will continue to mature until 15 May this year, meaning that investors who hold them will have to decide what to do next.

The default option for one-year bond holders is to be rolled into NS&I's one-year Guaranteed Growth Bond, which pays an interest rate of 1.45 per cent - just over half the 2.8 per cent interest rate on the 65+ Guaranteed Growth Bonds. There are a number of other options, as we explained in an article last month ('Think before you roll your pensioner bond', 22 December 2015).

However a reader wrote in asking: "Surely if one wanted to roll over for just one year you would be better advised to go for the five-year bond at 2.55 per cent and accept the 90-day penalty, earning 1.92 per cent for the year, rather than the paltry 1.45 per cent on the one-year bond?"

Danny Cox, chartered financial planner at Hargreaves Lansdown, says: "The maths works and, on this basis, you would be better off after one year. If you cashed in within 90 days of the reinvestment you would get back less than you invested.

"However, as a general rule, I am not keen on taking out fixed-term contracts with the view to cashing in early and suffering penalties. Depending on the provider, redemption charges might change, making the early encashment less attractive. NS&I does reserve the right to change its terms and conditions, although I wouldn't expect it to do so unless there were exceptional circumstances, such as excessive numbers of people cashing in early."

Patrick Connolly, certified financial planner at Chase de Vere, says: "The way the rates are tiered, so that the interest rates are higher when you select a longer duration bond combined with the way any exit penalties are structured, mean that if you're planning to save for just one year you will actually get a better return by selecting the five-year bond and exiting after one year than you would by selecting the one year bond."

But he also does not think this is an advisable strategy.

"This probably isn't something that NS&I would want advertised, although there doesn't seem to be any downside in doing it. I guess the overall risk is that if NS&I thinks people are doing it too much it might increase the exit penalties. However, that shouldn't be retrospective and so shouldn't affect those who have already invested."

However, Martin Bamford, managing director at independent financial adviser Informed Choice, says: "Where early access to a savings product is available and the penalty effectively reduces the real interest rate to a level higher than that earned from the shorter-term product, I can't see any reason why you would not follow this approach.

"Opting for the longer-term guaranteed growth bond allows a saver to hedge their bets. If interest rates remain lower for longer, which is what is currently being indicated by economists, then you would stick with the five-year bond. If interest rates started to rise and a more attractive guaranteed growth bond became available, or indeed if you needed access to the money earlier, then you could withdraw your cash early with the agreed 90-day interest penalty. You can also cash in part of the guaranteed growth bond, as long as you leave at least £500 invested."

This way you would only pay a penalty equivalent to 90 days' interest on the amount cashed in.

Mr Cox says another option is a cash Isa with an attractive rate of interest. "The NS&I bonds are taxable, so interest could be reduced by as much as 45 per cent," he says. "The taxation of savings accounts is changing and many will lose their tax liability from April. However, a maturing savings bond or investment marks a good time to review issues such as tax, and a reinvestment into an Isa tax shelter to save tax would negate the tax issue altogether and could provide a better net return."

From 6 April this year savings income will be paid without income tax deduction. If your interest on savings is less than £1,000 and you are a basic-rate taxpayer you will have no tax to pay. The limit for tax-free interest is £500 for higher-rate taxpayers and zero for non-taxpayers.

'Savings' include assets such as cash, corporate bonds, UK government bonds and interest earned on peer-to-peer loans.

  

NS&I Index Linked Savings Certificates

Savers in NS&I Index Linked Savings Certificates are in a similar situation to those in 65+ Guaranteed Growth Bonds in that there are no issues being made to new customers. However, investors with maturing Index Linked Savings Certificates have the option of rolling them into new issues of the same product. Savers can renew up to the total value of their maturing certificates, including all the interest and index-linking they earned, but cannot add any extra money to their certificates.

Interest rates on NS&I Index-linked Savings Certificates

TermInterest rate tax-free/AER (%)
2 year* **RPI +0.05 
3 year **RPI+0.05
4 year**RPI+0.05

*Only available when rolling over from existing two-year Certificate

Source: NS&I

**Retail Prices Index inflation (RPI) is 1.2 per cent.

"How attractive rolling over will be depends on what happens to the rate of inflation over the term," says Mr Connolly. "Inflation is expected to pick up from here, although probably not to the levels that savers enjoyed on their original product. However, you also need to consider that interest rates are still at historic lows and so most savings accounts are paying relatively little anyway. The only way to get a significantly better return is to take more risk."

He says that for savers who don't need instant access to their money, don't want to risk losing their capital and don't strongly believe that inflation will remain very low, there is an argument for rolling over their NS&I Index Linked Savings Certificates into new ones.