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BLOG: Pensioner bonds versus Isas

Cherry Reynard
Written By:
Cherry Reynard
Posted:
Updated:
21/01/2015

Investors’ unquenchable thirst for income was on full display last week with the launch of the NS&I pensioner bonds for retirees.

With supplies of these bonds limited, and the cash-beating returns on offer, the National Savings & Investment (NS&I) website crashed within minutes, while those ringing the NS&I call centre were kept on hold for more than an hour, according to reports.

The bonds, which are only available to those over 65, offer a headline return of 2.8 per cent for one year or 4 per cent for three years. Given that NS&I will accept just £10 billion of applications, the bonds are expected to fly off the shelves like hot cakes, with some forecasting these to sell out within a few weeks.

The appetite for these government-backed bonds, in an environment of perennially low interest rates is hardly surprising, but are these investments really the panacea for income-hungry pensioners?

Here’s how they measure up against a stocks and shares individual savings account (ISA).

Investment limits

With an ISA, you can invest up to £15,000 this tax year. This means a couple can potentially shelter a generous £30,000 within the ISA wrapper.

In the case of pensioner bonds you are limited to an investment of £10,000 in each version of the bonds. You can apply for £20,000 to be held singly under your own name (if you’re opting for both bonds on offer), or if you and your spouse are both over 65, you can apply for joint bonds.

Now, presuming you are fortunate enough that you and your spouse are able to allocate the full amount in each version of the bonds, you could shelter £40,000 in total, which is more than your annual ISA allowance for this year.

However, when the new tax year kicks in come 6 April 2015, you will have a new ISA allowance – this time rising to £15,240. If we take the total allocation you can put into an ISA over three years (the duration of the highest returning pensioner bond on offer), this will far outstrip the amount you can save into a pensioner bond.

It is also worth remembering that there is no cap on how large your ISA investments can grow, and the fact that the ISA allowance can now be passed between married couples on death. This means the surviving spouse retains the benefit of the savings in the ISA held by the deceased, giving them the benefit of the additional allowance regardless of whether they are the deceased’s beneficiary or not.

Tax efficiency

The other key point to remember is that once you put money into an ISA wrapper you need never worry about tax again (you don’t even have to tell the tax-man about these savings).

In the case of pensioner bonds, however, you are subject to tax on your earnings from these vehicles, which substantial reduces the headline returns on offer.

For a basic rate taxpayer, your after-tax return will be 2.24 per cent and for a higher rate tax payer 1.68 per cent on the one-year bond, while the three-year bond offers an after-tax return of 3.2 per cent for a basic rate taxpayer and 2.4 per cent for a higher rate taxpayer.

NS&I take off tax at the basic rate (20 per cent) when they add the interest to your bond, which is only paid at the end of the bond’s term.

Higher and additional rate taxpayers will need to declare the interest to HMRC and pay any further tax due, while non-tax payers will also have the additional administration of applying to the tax man for a refund.

Accessibility

To get the full return from your pensioner bond, you will need to keep your money invested for the whole of your chosen term.

While you can cash in all or part of your bond early, you will suffer a penalty from your payment equivalent to 90 days’ interest on the amount you cash in. Bear in mind that if you cash in all of your bond within 90 days of investing, you will get back less than you originally invested.

You also can’t change your mind about this investment. As 65+ Guaranteed Growth Bonds are fixed rate investments with a set term, there is no right to cancel.

In contrast, an ISA allows you access to your savings any time you want. While you should ultimately be investing for the long term, many investors will cherish this accessibility.

They might for example use the tax wrapper to shelter their rainy day funds – ensuring they have some money to deal with unexpected events but are still earning a decent, tax-free return.

Income flexibility

With the new pensioner bonds, you only receive the interest you’ve earned on your bond when it matures. But most retirees will be relying on a regular income payment to top up the money they receive from a pension arrangement.

With a stocks and shares ISA you can invest in a basket of income funds paying you a dividend either on a yearly, quarterly or monthly basis. You can also hold bonds with different maturing dates and then match these payments with the specific time periods when you need income. Likewise, you could hold company shares in an ISA which could also pay dividends according to a regular schedule.

Income payment dates can be a useful way to construct a plan to draw down income from your stocks and shares ISA, ensuring you receive a reliable and constant income stream.

Unfortunately, with pensioner bonds there is none of this flexibility – retirees will have to wait until the end of the bond’s period to receive their income.

Also bear in mind that with an ISA you can invest regularly – as we have pointed out before the advantages of this approach are plenty – you avoid the risk of buying low and selling high and over the long term smooth out market volatility. You also don’t have to come up with a large sum of money to get started. With a pensioner bond, you will have to stump up a lump sum – from a minimum of £500 up to a maximum of £10,000 per bond.