Most of us would consider tucking some cash away for three years, maybe even five, in exchange for good interest rates. But when you go beyond that, the negatives start to outweigh the positives. So although you might be tempted by the 2.2% interest rate offered on Shawbrook Bank’s new savings account, there are several reasons why you should avoid this long seven-year fix.
First, the interest rate isn’t great. If you are going to give a bank your money until 2024, you should at least be getting a table-topping interest rate. Already, you can beat Shawbrook’s 2.2% by opting for Paragon Bank’s five-year bond. This pays 2.25%, and you get your money back two years earlier. Alternatively, NS&I’s three-year bond also pays 2.2%.
Next, there’s inflation. Considering that inflation is currently 2.7% and is widely predicted to rise further, locking your money away for a long time in an account paying less than inflation is madness. If the cost of everyday goods rises faster than the pace at which your money is growing, your cash will lose purchasing power every day it is in that account. You may be better off going for a short-term account and reinvesting it in a year or two. That way, if rates rise you won’t be left behind.
Third, consider whether it really makes sense to lock away cash for seven years (remember that with fixed-rate savings accounts you usually can’t access the money before the end of the term). If you know you aren’t going to need your savings for that length of time, consider taking a bit more risk and investing in assets such as bonds, funds or shares, which have historically offered better returns over the long term.
Finally, consider the tax implications. If you choose a long-term fix that is not an individual savings account (Isa), you could face a tax bill if you earn interest above a certain amount (£1,000 for basic-rate taxpayers, £500 for higher-rate). Interest on fixed-rate accounts tends to be paid in one lump sum on maturity, so the amount you earn could easily exceed your allowance that year and leave you with a nasty tax bill.
Where to put your cash instead
If you want to tuck some cash away for five years, then Paragon Bank’s five-year bond pays a better rate of 2.25%. The minimum opening balance is £1,000 and the account can only be operated online. However, it doesn’t make much sense to open this account for smaller amounts (up to £3,000) when you can get almost the same rate over three years from National Savings & Investments (NS&I). The Treasury-backed bank is offering 2.2% over three years with its Investment Guaranteed Growth Bond. Ignore the word investment in the title – your money remains in cash and there is no risk with this account whatsoever.
If you would rather fix for a shorter time in the hope rates will rise, then Paragon Bank is paying 1.7% over two years, or Charter Savings Bank is paying 1.55% on its one-year bond. However, both those accounts fail to keep pace with inflation – so your money will be shrinking in real terms.If you are putting away relatively small sums, a better option may be to put your money in a high-interest current account. Nationwide’s FlexDirect account pays 5% on balances up to £2,500 for the first 12 months, while Tesco Bank pays 3% on up to £3,000.
If you are prepared to take on some risk for the prospect of a better return, you could consider peer-to-peer (P2P) lending, which involves lending your money to an individual or business. For example, Ratesetter is offering 4% over five years, while Funding Circle says you can earn up to 7.2% a year. However, these accounts are not covered by the Financial Services Compensation Scheme. Some big P2P lenders operate provision funds to cover potential defaults, but this still does not guarantee you will get your money back.
In the news this week…
• Soaring property prices and a nil-rate band frozen at £325,000 since 2009 have seen so many estates drawn into the inheritance tax (IHT) net that, on average, residential property now accounts for a third of IHT bills, says Vanessa Houlder in the Financial Times. Hence David Cameron’s promise to raise the IHT threshold to £1m, and the advent of the “family home allowance”. The new allowance, also known as the residence nil-rate band (RNRB), adds £100,000 to the nil-rate band in 2017-18, rising to £175,000 in 2020-21. Since a couple, provided they are married or in a civil partnership, will have two nil-rate bands and two RNRBs between them, they will eventually be able to pass on a £1m property to direct descendants.
The RNRB applies only when houses, or part of them, have been owned by the deceased and included in their estate. They must also have been lived in by the deceased at some stage. If one partner died before 6 April 2017, the RNRB can be transferred to the surviving spouse, even if they didn’t own the property. Additionally, those who downsize or sell their homes (as long as it took place on or after 8 July 2015) can “bank” their RNRB to be used against a smaller home or against the remaining value of their estate. The downsizing rules related to IHT are so complex, however, that professional advice should be sought.
• Insurers are taking advantage of loyal customers by pushing up premiums while luring new customers with cheaper deals, says Jeff Prestridge in The Mail on Sunday. “Hundreds of thousands of people have longstanding cover that is no longer fit for purpose – but no one has bothered to tell them.” It is “about time” the industry found a way of updating existing policies so that all customers are treated fairly.
A number of insurers, led by Aviva, have now promised to “stop discriminating against loyalty”. But while Aviva boss Mark Wilson “contemplates his insurance navel”, anyone sent a renewal notice should “at the very least” challenge their provider. A work colleague recently called British Gas and his £50 premium increase was immediately swapped for a £170 discount. “What a gas.”