Taking Account
  • Taking Account

Is your deposit account up to scratch?

Summer 2007

Any advertisement for an investment fund normally carries the warning that its capital value and income can go down as well as up. There is no such warning for deposit accounts.

While capital values of deposits are fixed (ignoring the effects of inflation), income from most deposits is variable. The extent to which it varies can be very marked. For example, with base rates at 5.5%, a 0.25% interest rate cut would mean a reduction of £45.45 a year on a base ratelinked income that is currently £1,000 a year. Less than four years ago, base rates were at 3.5%, and if rates were to return to that level, your interest from a deposit account linked to base rates would fall by over a third.

What is more, banks and building societies have become masters at the art of tweaking rates, and sometimes do not give investors the full value of Bank of England base rate increases. One high profile bank has gone as far as to ignore several base rate increases completely. On the other hand, whenever base rates are cut, the reductions are often fully reflected in the interest rates offered to investors.

Deposit accounts certainly have their place, but they can have significant drawbacks for generating a dependable income.

If you want more certainty about the payments into your bank account, there are plenty of options available, although you should take their tax treatment and the possibility of capital erosion into account.

Guaranteed Income Bonds give you a fixed income for your chosen term and full capital return at maturity, although if you cash in the bond before maturity, you may receive less than your original investment. If you are a higher rate taxpayer, these bonds have two useful tax advantages:

  • Your higher rate tax liability is 20% of the net income you receive, whereas for a deposit it is 20% of your gross income.
  • The whole of your tax liability on the income will generally be deferred until maturity.

Fixed Interest Funds invest in fixed interest securities, such as government bonds (gilts) and corporate bonds. The income from these funds is not fixed, but varies according to the underlying investments. However, fund income is not linked to base rates and is normally more stable than deposits. If these funds are held in an Individual Savings Account (ISA) or a Personal Equity Plan (PEP), interest is paid tax free. Unlike deposit accounts, this is investment where capital values can go down as well as up and past performance is not a guide to future performance.

Withdrawal Schemes are widely used to provide regular payments from a variety of investments such as funds or investment bonds. You choose how much you wish to withdraw and the payments are made regularly to your account. The payments are normally a mixture of income and capital, so if your rate of withdrawal is higher than the overall return on your investment, the value of your investment will be eroded. Withdrawal schemes are particularly suited to investments where the bulk of the expected return is through capital growth. The value of these types of investment can fluctuate and you may not get back the full amount you invested.

Hilton Sharp & Clarke