Fixed-Rate Bonds: How the Savings Work
Fixed-rate bonds are a type of savings account that guarantees an interest rate over a set period of time.
Are you struggling to earn much interest on your cash savings? One way you can boost your interest rate is by locking your money away for a while. If you’ve got a lump sum you won’t need to get your hands on soon, consider putting it in a fixed-rate bond.
What is a fixed-rate bond?
A fixed-rate bond is a type of savings account in which you put your money away for a set period and agree not to access it. (It may also be referred to as a fixed-rate savings account.) In return, you should get a better interest rate than you could expect on an easy access savings account.
How do they work?
You can find fixed-rate bonds with terms of one to seven years. Generally speaking, the longer you lock away your money, the better rate of return you will get, because the provider has the certainty of knowing how long it will have your money. Be sure you can afford to be without that cash for the whole term of the bond. That’s because, depending on the terms and conditions of the account, you may not be able to access your cash at all if you suddenly need it. Some providers will allow you to withdraw your money early but will then close the account and you will forfeit interest or pay a fee.
In a fixed-rate bond, your money is protected up to £85,000 under the Financial Services Compensation Scheme in the unlikely event your UK-regulated provider goes bust.
Interest will usually be paid every year, although some bonds pay out when the term ends and some may allow you to take the interest out monthly, effectively giving you a regular income. Some providers will allow interest to be compounded, meaning it's paid back into the account so that you earn more interest on it, while others specify that interest must be ‘paid away’, meaning it will be paid into the account of your choosing.
It’s also worth bearing in mind that you need to be on the ball when your fixed term ends. Your provider should write to you asking what you want to do next, but if you don’t respond in time, they could roll your money over into another fixed-rate bond, locking up your money for longer and possibly at a lower interest rate.
Do you pay tax on a fixed-rate bond?
The interest your savings earn in a fixed-rate bond could be taxable if it goes above your personal savings allowance. For basic-rate taxpayers, the allowance is £1,000 a year. It's £500 a year for higher-rate taxpayers, and £0 for those in the additional-rate tax bracket. This is how much you can earn in interest each tax year across all the savings products you hold. Because the rate on a fixed-rate bond doesn’t change, you’ll know exactly how much interest you’ll get, so you can plan ahead to be as tax-efficient as possible.
How do fixed-rate bonds compare to other savings accounts?
Unlike other types of savings account, with a fixed-rate bond you often pay in a lump sum when you open the account and then that’s it, the door is locked and there are no more chances to deposit money. (Some accounts allow you to make extra deposits, but only for a short while.) That’s why these accounts are good for people with a decent-sized lump sum — say, an inheritance or proceeds from a property sale — that they can afford to park.
How do fixed-rate bonds compare to fixed-rate cash ISAs?
A fixed-rate cash ISA is similar to a fixed-rate bond in that you lock your money away for a set period of time in exchange for a set rate of interest. However, there are some key differences.
- You can pay into only one cash ISA in each tax year, while you can hold as many fixed-rate bonds as you like.
- You can pay in a maximum of £20,000 into ISAs of any kind in each tax year (this is called your ISA allowance), while the only limit on fixed-rate bonds will be what each provider sets.
- With a fixed-rate ISA, you won’t pay tax on any interest your money earns, but with a fixed-rate bond you may have to pay tax if the interest earned is more than your personal savings allowance. (For this reason, a fixed-rate cash ISA could be a better bet for higher earners who don’t get a personal savings allowance.)
How to choose the best fixed-rate bond
Probably the two main things to consider are the interest rate the bond pays, and the length of the term. But also think about how you want to manage the account — for example, is online access important, even though you won’t be making any withdrawals from your bond? Or would you consider an account managed in branch or by post if it meant getting a better rate?
How to get a fixed-rate bond
First, have a look online to see which accounts are currently offering the best rates. When you’ve selected the account you want, apply to open one. You’ll often be able to open fixed-rate bonds online, although some providers may want to deal by post or phone.
Usually you will need to be over 18 to open a fixed-rate bond. Make sure you’ve got a lump sum ready to put straight in, and note down when the bond matures so you can be ready to switch to another good deal when the term ends.
Hannah is an award-winning journalist with a background in the trade press. She writes about finance, asset management and business for Shares, Citywire, FE Trustnet, and interactive investor. Read more