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Post Office Inflation Linked Bond

Savings Account
Published 20 February 2011
Helpful? 30
Open Quote A very competitive product of its type, although taxpayers will lose out. But the big question is whether inflation will remain high, as this will determine how attractive this bond ends up being.End Quote
Thumbs Up
  • Protects your savings from rising inflation.
  • Generous rate vs BM Savings
  • Nice and simple.
Thumbs Down
  • It's taxable, so taxpayers will likely lag inflation.
  • No withdrawals allowed.
  • Interest only paid at maturity and no compounding meanwhile.
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The new Post Office inflation linked savings bond is similar the BM Savings bond that I recently reviewed, except that it pays a higher rate of interest over and above inflation.

The bond, launching on 22 February, runs for 5 years and pays 1.5% plus inflation (measured by the Retail Price Index) each year before tax.

Interest is calculated annually on 27 May, based on inflation over the year to the prior April. However, it's only paid out at maturity and you don't benefit from interest on interest (i.e. compounding) meanwhile. And this latter point could cost you around 1% in total over the 5 years versus receiving annual interest and earning 3% a year on it elsewhere meantime.

The key detractors are that returns are taxable and you can't withdraw your money before maturity - which may make the bond irrelevant for some.

But if you are happy to tie up your money for 5 years and have concerns over rising inflation then is the Post Office Bond likely to be worthwhile?

The 'best buy' 5 year fixed rate savings account (Principality Building Society) is currently paying 4.85% a year, so for the Post Office Inflation Linked Bond to deliver a higher return average inflation would need to exceed 3.35% over that period.

Is this likely? Possibly, but it's by no means certain. The last published RPI figures show an annual increase of 5.1% to January 2011. But the majority of this was due to higher oil/food prices and the VAT rise, all of which might not rise by as much in future (see our article for more info). If it's any help, markets seem to be predicting average RPI of 2.94% over the next 5 years based on index-linked gilt prices at the time of writing.

You also need to bear in mind that the current 5.1% RPI figure relates to price rises over the last year, whereas what matters with this bond is the extent that prices rise in future.

But if you do believe inflation (RPI) will average more than 3.35% over the next five years then this Post Office Inflation Linked Bond looks very appealing, especially versus competitors.

Taxpayers will be disappointed this bond isn't available within a cash ISA, as they'll very likely lag inflation after the taxman's taken his cut. Higher rate taxpayers in particular might do better opting for a cash ISA (assuming they don't want to save more than the annual ISA allowance).

For example, the Northern Rock cash ISA paying 4.3% fixed for 5 years equates to 7.17% gross taxable interest for higher rate taxpayers. RPI would have to average 5.67% for the Post Office bond to match returns, after tax. The equivalent RPI rate for basic rate taxpayers is 3.88%.

The bond is available by Internet or phone between 22 February and 27 April (it could close earlier if demand is high) - there's no bonus for applying early, sp you could lose a little interest meanwhile. The minimum investment is £500 and maximum £1 million.

Although inflation is hard to predict, I'm pretty certain it won't remain as high as current levels for the next 5 years. So I wouldn't pile into inflation-linked savings bonds on the basis of 5%+ inflation.

Nevertheless, the Post Office Inflation Linked Bond looks very competitive versus the BM Savings variant and could make sense for non/basic rate taxpaying savers who wish to hedge some of their cash against rising prices. After all, beating inflation, after tax, should be the ultimate goal for all savers.

Web Link: http://www2.postoffice.co.uk/finance/savings-investments/inflation-linked-bond

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