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.


Your Comments

If you investigate NSandI index linked bonds I believe that you will find that interest is based on the ANNUAL INCREASE in the RPI - NOT ON THE RPI ITSELF.
Therefore if there is no increase in the RPI on the bonds anniversary, you merely get 0.25% in the first year, 0.35% in the second, 0.4% the third then 0.65% in the fourth and 0.86% in the fifth.

This account wont pay out any index-linked interest if the RPI rate at the end of each anniversary is lower than at the start! In this case you would only get the top up interest.

The first two comments are correct about the calculation but are missing the point. NSI are using a fair method to calculate inflation. RPI is an index of prices relative to (in this case) Jan 1987. If when you take out your certificate this index is 200 (i.e. prices have doubled relative to 1987) and at the end of year 1 it is still 200, NSI calculate (correctly) that the inflation - over the year you have held the certificate - is zero since your money is worth the same now as it was a year ago. This is even if the annual change has fluctuated in the meantime, but remember these annual figures refer (in part) to a time before you took out the certificate! The annual RPI is pretty volatile but over the last 20 / 10 / 5 years has typically hovered around the 3-4% mark so this may continue as the third comment hopes but this cannot be guaranteed. For example, in 2009 the annual rise was zero or negative for 9 months of the year. It is also worth noting that the NSI calculation process "starts again" each year i.e. the calculation for year 2 compares the index at the start of year 3 with the index at the start of year 2.

Is this correct? If so its a bit worrying!

I invested quite a bit earlier this year and I though how it worked was that the index linking would track the average RPI over each year, not any increase from the start of the bond to bond anniversary.

If its merely any increase in the RPI- ie from say 3% at the start to 4% at first anniversary and so on I can't understand why this product has been so popular? After all RPI could fall in that period so there would be no increase.

Can someone on here clarify?

No, don't worry, it's not the increase from 3% to 4% that you'll get, it is 3% one year and 4% the next.

The interest rate is based on the RPI increase each year using as the start month 2 months before the investment because this is the latest available. The increased value of investment is used for a similar calculation for the second year etc. The annual fixed % is added but this increases each year with the overall average the stated figure.

All is explained on the NS&I website:
Choose: "index linked savings certificates", click on "find out more" and then choose "how they work". There is even a calculation to show how the interest is calculated.