Deciding where to put a lump sum is a significant challenge in the context of a declining savings market.
It is getting harder and harder to eke out a decent return, and the situation doesn’t look set to improve as long as Bank Rate remains at 0.5pc.
However, short of interest rates turning negative, it will always be beneficial to put a lump sum somewhere where it will generate some form of return. Leaving £60,000 sitting in a current account earning 0pc is essentially throwing away money, as even with inflation as low as it is, that money is still de-valuing over time.
The new personal savings allowance looks set to improve things marginally for savers, by providing all basic and higher rate taxpayers with a tax-free allowance on savings earnings.
However, for those who have a total income of less than £17,000 per year (for the 2016/17 tax year), due to living on a retirement income for instance, the savings allowance is irrelevant, as they won’t have to pay any tax on savings interest at all.
AT A GLANCE
Personal savings allowance
- From April 2016, everybody will get a personal tax free allowance for interest earnings on savings
- For lower rate tax payers this will be £1,000
- Higher rate tax payers will only receive a £500 allowance
- Anyone earning more than £150k a year will not receive a personal allowance
- Beyond the allowances, lower rate taxpayers will pay 20pc on savings income, and higher rate taxpayers 40pc
And unlike previous years, where it was necessary to register to have interest paid gross, banks will no longer be deducting tax at source, instead paying gross automatically.
With £60,000 and no savings tax liability (assuming income stays below £17,000, including savings earnings), fixed-rate bonds are the best savings option out there.
High interest current accounts offer better rates but have far too many caveats and conditions to satisfy for this scenario, and the rates are subject to change.
An Isa would only be worth looking at if total income was likely to exceed £17,000 at any point, and the cost of tax on earnings above the personal savings allowance was enough to balance things in the Isa’s favour (as they have lower rates across the board).
Which bond to save into depends on how long the money can be locked away for, and whether it is an annual yield or maximum value at maturity that is desired.
Secure Trust has the best five year fixed-rate bond in terms of rate at 3.11pc. However, the interest earned (which is paid annually) can’t be re-invested, meaning this is only the best option as an annual income stream.
With a £60,000 deposit, the account would pay £1,866 out in interest annually.
The best bond to maximise total earnings is First Save’s five year fixed-rate offering, which pays 3.06pc. Despite the lower rate, interest can be re-invested, leveraging a greater overall return.
A £60,000 deposit with all of the interest re-invested would be worth £69,906 at maturity (if interest is paid annually), around £600 more than Secure Trust’s total after five years.
Both of these providers hold their own Financial Services Compensation Scheme (FSCS) licenses, meaning deposits are protected up to the value of £75,000 (per person, per firm).
If five years is too long to lock away for there are one, two, three and four year fixed-rate bonds to consider too.
Rates on these range from 2.06pc to 2.65pc – the top rates for each term length can be found here.
Some of the best buys, such as bonds from RCI Bank, are not covered under FSCS and are instead covered by European equivalents. In these cases, it may be worth giving up a few percentage points of interest for the added security that FSCS protection provides.
The investment option
A higher return could be generated through investing, either through bonds or shares on the stock market.
This would involve taking risk and would only be suitable if the initial capital was not required for at least ten years.
Investing has been shown to outperform savings rates over the long term, but that is not guaranteed. An annual return of 4.5pc (a figure often quoted by financial advisers) might be expected after all fees are deducted, if all dividend income is re-invested.
The best way to invest is through a fund platform, an online service where you can select investments and view your portfolio. It is unwise to try and pick individual companies to invest in yourself; instead, invest in a small number of funds.
There are “tracker” funds, which have lower charges and simply buy all the stock in an index – the FTSE All Share, for example – and weight their holdings depending on the size of companies in the index. Alternatively, actively managed funds come at a higher cost and employ a fund manager to make decisions about where to invest.
Additionally there are online “robo-advice” services such as Nutmeg which generate an automatic portfolio depending on the information provided.
Both the platform and the fund you invest in will charge a fee, but generally a 1pc total cost for both fund charges and platform charges would be reasonable. There needs to be a very good reason – such as a fund with a consistent history of beating the market – for fees to be higher than that.
If heading down this route, talking to a financial adviser is recommended, as there is the potential to lose significant amounts of money. It may also be worth considering not investing everything, to maintain a contingency fund.
SOURCE: Telegraph
