With the end of the tax year in sight and ISA season now upon us, this is traditionally the time of year when banks and building societies unveil their top-paying fixed rate cash ISA deals. However, based on research carried out by Fair Investment Company, rates on one, two and five year fixed rate cash ISAs have fallen by up to 40% compared to a year ago. With plummeting interest rates across the board, many savers are starting to look beyond traditional fixed rate accounts in order to maximise the potential of their hard-earned cash.
Does it still pay to lock away?
Received wisdom has always been that the way to get a better rate of return on cash savings is to tie up capital in a fixed rate account. However, a recent study of the fixed-rate cash ISA market* shows that fixed-rate cash ISA interest had fallen by more than 30% when compared to rates one year ago, with a difference of over 45% in some cases. For example, Aldermore offered a one-year fixed rate ISA with a £1,000 minimum deposit at 3.25% in March 2012 – at the time of writing, this same plan now offers just 1.74%, a fall of over 46%. In contrast to this, some instant access ISAs, such as Nationwide’s instant access cash ISA, offer 2.25% gross on balances as low as £1.
What are the alternatives to fixed rate ISAs?
If you’re considering locking cash away for three years or more, but are deterred by the current low interest rates offered by fixed rate ISAs, you may want to take a look at structured deposits plans as an alternative option. These plans are designed to strike a balance between protecting your capital and offering the potential for market-linked returns.
A structured deposit plan is a fixed term investment with a payout that is linked to the performance of an underlying asset e.g. the FTSE 100. Structured deposit plans are appropriate for people who have a low appetite for risk but are willing to accept a return on the deposit that involves limited exposure to the stock market. While returns are not normally guaranteed in structured deposit plans they offer the potential for competitive rates of return over fixed term bonds. When interest rates are low they can offer investors relatively low risk exposure to market performance.
In a deposit plan money is held with a deposit taker such as a high street bank. Capital is at risk if the deposit taker is unable to meet its liabilities and repay investors. As with a savings account in the event of default of the deposit taker you have recourse to the Financial Services Compensation Scheme (FSCS) which currently covers an individual up to £85,000 per authorised institution.
What plans are currently available?
3 year term plans
Investec’s 3 Year Deposit Plan offers a fixed return of 15% (gross) if the value of the FTSE at the end of the term is higher than its starting value, subject to averaging. This equates to around 4.31% compound. If the FTSE 100 falls is below the starting value at maturity you will only recieve your original capital back.
5 and 6 year term plans
The Growth Deposit Bond from Legal & General also links your return to the FTSE by offering 115% of any rise in the Index over the six year term but capped at 40%, which equates to a maximum potential return of 5.7% a year compound.
For those who do not want a cap on any potential returns and prefer a 5 year timeframe rather than 6 years, Investec’s Deposit Growth Plan will return any rise in the FTSE over the term of the plan (subject to averaging) without any upper limit. The downside to these two plans is that if the FTSE only goes up by a small amount or goes down over the term, a fixed rate may have paid a higher return. They are therefore designed for those who expect the FTSE to rise in the future, catering for 5 and 6 year timeframes.
Early maturity plans
The ability to mature early is a feature which is unique to structured products. Investec’s Kick Out Deposit Plan offers a potential 4% per annum (not compounded) with the opportunity to mature early provided the value of the FTSE 100 at the end of each year (from year 2 onwards) is higher than its value at the start of the plan.
This means a return of 8% could be yours after just 2 years and even if the plan runs for the full 5 years and then kicks out, this deposit offers the potential for more than a 1% premium on longer term fixed rates.
If you require income , Societe Generale’s UK Range 7 Plan 3 offers the opportunity for an attractive 7% (gross) for each year the FTSE stays between an upper and lower range based on its level at the start of the plan. This range increases each year, starting at +/- 12% in year 1, and then increasing by +/- 2.6% thereby providing a wider range each year within which the FTSE can move. If it moves outside the range, the income is not paid for that year. The plan has a 6 year term.
Since the returns are not guaranteed, these savings plan alternatives are not designed to meet the entire needs of every saver. However what they do is provide a defined return over a defined term compared to other savings options currently available.
As with any savings product, there is always a trade off for receiving a higher rate of return and with structured deposits, this is made absolutely clear at the outset. The two main downsides are that the deposit taker may go into liquidation (as with any deposit) and that the payout mechanism within the plan does not occur so you only receive your capital back.
This has to be balanced and compared to the upside which is inevitably a greater return than could be achieved by putting you money away for the same length of time with a similarly rated credit institution.
* Data Source: Moneyfacts, February 2013