Savers turning from ISAs to Fixed Rate Bonds

It is common knowledge that Individual Savings Accounts (ISAs) have been offered as the “no-brainer” tax free method for saving without having to pay tax on the interest earned. But recent surveys show that they may no longer be the best option.

ISAs were first launched 10 years ago in April 1999, offering savers the best rates on the market. But things have changed, and despite the attract feature of tax-free returns, savers may find they can get higher returns using high interest savings accounts and fixed rate bonds, while using their ISA allowance to invest into stocks and shares.

Nationwide enraged its ISA customers last month, after paying significantly higher rates on its two and three year fixed rate bonds with similar terms and restrictions. The building society currently holds around a fifth of Britain's personal savings.

Nationwide were offering a 3 year fixed rate bond paying 4.15% interest (3.32% after tax), but the ISA version offering virtually the same 3 year fixed rate bond ISA paid just 3.3%.

The good news is that after this was highlighted by the Guardian newspaper, Nationwide increased its cash Isa rates to 3.75%. The bad news is that these new rates do not apply to existing customers, so if you opened an account when the rates were low, you will not benefit from the increase. The higher rates now offered are still marginally lower than those offered on its standard fixed rate bonds (before tax).

Halifax is also paying much higher rates on fixed rate bonds than its ISA equivalents, with its 2 year fixed rate bond paying 4.15%, but its 2 year fixed rate ISA paying just 3.5%.

What's more disheartening is that many of those that choose not to lock their cash away and go for instant access cash ISAs have seen rates fall to pitifully low levels.

For example, Halifax is paying just 0.1% on balances up to £17,999; 0.15% up to £26,999 and 0.25% on anything above this.

Although this news may put off many ISA savers, there is also another side to ISAs that may suggest cash ISAs are not the best accounts when looking to take advantage of tax free returns, offering the potential to smash these rates. This alternative is by use of investment bond ISAs, offering rates that are determined by the success of the investment, and can prove to be very profitable. Investment bonds rate higher in terms of returns, but only if the bond you invest in makes money.

There are several different types of investment bonds, but the general rule with them is that in order to increase your potential returns, you must increase the risk you put in, whether this be simply risking the interest you could earn while protecting your initial deposit, or aiming higher and risking your entire investment.

What you need to remember is that the rates offered on investment bonds tend to be projected estimates, so your returns could differ to the amount originally advertised.