Should you invest in the NS&I inflation-linked bond?
Experts are warning savers to act fast if they want to invest in NS&I's new five-year inflation linked bond.
The government-backed savings institution was forced to withdraw its fixed and inflation-linked savings certificates in July last year as it could not meet demand from savers, keen to get a positive return on their savings as inflation continued to climb.
However, following an announcement in the last budget, NS&I has now confirmed a five year savings account paying inflation (based on the retail price index) plus 0.5%. Currently this would provide a return of 5.7%.
The product's return is undoubtedly great news for savers, but the five-year deal won't be for everyone. Moneywise examines the pros and cons.
* You can open one with as little as £100. The maximum investment is £15,000.
* They are tax–free. That means on top of the index link and 0.5% interest, you don't have to return any of your gains to the taxman, which equates to a basic rate taxpayer getting 0.63% interest on top of the index link while higher rate and additional taxpayers receive 0.83% and 1% interest respectively.
* NS&I is backed by the government - meaning 100% of your savings are protected.
* The bonds are linked to the retail prices index (RPI), which is currently 5.2% rather than the lower 4.5% consumer prices index. Historically RPI (which includes mortgage interest payments, council tax and other housing costs) is higher than CPI so you are guaranteed to be tracking the higher measure of inflation.
* Even though the bonds are for five years, customers can access their money early and provided that this is done after one year they will still get some interest and the full index link.
* Your money is tied up for a long time. To fully benefit from the interest and index link you will need to not touch your money for five years. Many savers will therefore not want to put all their money into an NS&I bond.
* The inflation rate on which the return is based is calculated on an annual basis not monthly. This means you won't benefit from any short-term increases to the RPI.
* Inflation could fall in the coming years, reducing the return on your savings. In his latest inflation report, the Bank of England governor, Mervyn King, hedged his bets saying "the chances of inflation being above or below the [2%] target in the medium term are judged to be about the same." Although in the same inflation report foreword he also says that inflation is expected to drop in 2012 and 2013.
However, industry experts are generally in agreement that inflation will decrease in the short term. Justin Modray, founder of Candid Money explains: "The higher RPI figure has been driven by rising food and energy prices but there's a fair chance that these will fall and so inflation could fall too."
If inflation falls, interest rates are more likely to rise making conventional savings plans more competitive by comparison.
* You won't receive any interest or benefit from the index link if you take money out before one year. Even though you will receive interest and the index link if you close your account after a year, you won't necessarily get the full amount of interest. The promised 0.5% interest is averaged out over the years so in the first year NS&I pays 0.25%, 0.35% in the second, 0.4% the third then 0.65% in the fourth and 0.86% in the fifth.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).