Investment Bonds

'Bonds' is a cover-all term which includes everything from fixed rate savings bonds and insurance bonds to bonds linked to stock market indices.

All that these have in common is that as bonds, you're unlikely to be able to get at your money as easily as you would with an investment fund or an easy access savings account.

Here are some of the ones you'll come across.

1. Fixed rate savings bonds

These are simply savings accounts with a rate of interest which does not change during the term you are invested.

You agree to tie your money up for a certain period of time - for example one year or even five years - called the term.

The bank or building society pays you interest that is usually higher than you can earn on an account where you have easy access to your money.

They usually pay a fixed rate of interest but some are variable which can rise and fall over the term. At the end of the term you have access to your money.

Interest is taxable and paid after basic rate tax. Higher rate tax payers have to pay the extra.

As a non-tax payer fill in form R85, available from banks and building societies so your interest is paid to you before any tax is taken off. 

Generally you should only use them if you won't need the money during the term.  Some bonds do allow withdrawals before the end of the term but charge penalties;  others allow a few withdrawals a year or allow you to take out up to a certain percentage of your savings.

And make sure you move it at the end of the term, or you'll end up earning a very poor rate of interest.

You can take a look at the fixed rate savings bonds currently on the market here.

2. Investment bonds

With these, you invest a lump sum with an insurance company. You get a little bit of life cover, but the rest is invested.

Your money could be put into a with-profits fund, or other fund run by the insurance company.

Usually you can withdraw 5% a year without any immediate tax liability. But bonds can be high-charging, and the tax incentives on Isas are more attractive.

3. Guaranteed growth bonds

These are bonds where your return is linked to the performance of a share index, but you are promised the return of your original capital.

Also known as structured products, these bonds are complicated and even though you might know you'll get your original money back, you could be giving away some of the upside to get this.

4. National Savings and Investments

National Savings & Investments (NS&I) is one of the largest providers of savings and investments in the UK.

Rather than being a private organisation (like a bank), NS&I is backed by the Treasury. Because NS&I is backed by the Treasury, there is no risk of you losing your cash: everything you invest is 100% secure as well as the interest you’ve been promised.

A bank will typically re-invest your savings to generate profit. Investing in NS&I, however, means you are lending money to the government, to finance public spending.

Premium Bonds: You buy these bonds, minimum £100, and every month you are entered into a draw.

Each month the winners receive tax-free prizes ranging from one prize worth £1 million and over a million other prizes of between £100,000 and £25.

Parents, guardians, grandparents, great grandparents can buy Premium Bonds for children under the age of 16.

You can sell them at any time for what you paid for them.

Income Bonds: These are savings to which you have access at any time. You receive interest every month rather than just yearly.

Rates are variable so they will change with the general level of interest. Interest is paid before tax is deducted.

Fixed rate Certificates: You agree to tie your money up for a certain period of time - typically three or five years - and earn a fixed rate of tax-free interest. If you cash them in before the end of the term, you will not earn the advertised rate.

Index-Linked Certificates: You tie your money up for two or five years and earn interest plus inflation, as measured by the retail prices index (RPI).

Although the rate fluctuates as the RPI changes at least you know you will always be earning more than the rate of inflation. 

One of the main advantages is that you pay no tax on the return.

Children’s Bonus Bonds: A five-year fixed rate plan for adults to put money away for children and earn tax-free interest.

You can find out more about NS&I products here.

5. Government bonds

British Treasury Stock - or gilts - are IOUs issued by the government.

You lend it your money over a fixed term and it pays you a fixed rate of interest while it has your money.

At the end of the term it pays you back the amount you lent it. However, during the life of the bond, you can sell it on the stock market.

Prices change and you may get back less or more than you paid if you sell before it reaches its maturity date.

Your money is 100% guaranteed by the government and you can invest small amounts. Your interest is usually paid out before tax, but is taxable.

6. Corporate bond funds

Corporate bonds work in the same way as government bonds - the only difference is you are lending your money to companies rather than the government.

They tend to pay higher interest - but they are not as safe as UK government bonds: if the company goes bust, you could lose your money.

The interest varies depending on the financial strength of the company issuing the bond. Those which are not as well established pay higher rates, as there is a higher risk of them defaulting on the loan. These are also known as junk bonds.

The main way to invest in these bonds is through investment managers, who run pooled funds for private investors. This is because the minimum you can generally put into a corporate bond is very high.

The fund manager picks bonds to invest in but rarely holds them to maturity. Instead they buy and sell them in the market depending on whether they reckon they are a good deal or not and whether they think they'll go up in price.

So - your income from these bonds is not fixed, but the manager looks to keep it steady.

If you hold these bonds in an ISA, there is no tax to pay.

7. Corporate bonds

Private investors can buy individual corporate bonds directly through a recent scheme called the order book for retail bonds - or ORB. You do it by going through a stockbroker.

Well-known strong companies such as John Lewis and Tesco have issued bonds through this route with a minimum investment of £1,000.

If you hold these bonds in an ISA, there is no tax to pay.

8. Stock market-linked bonds

Sold by insurance and investment companies as well as banks and building societies, these link your investment to the performance of the stock market.

They will give you a return plus your capital back if the stock market rises over the investment term, typically five years.

If the stock market ends up at a lower level than when you invested, you get your money back.

However, there are some bonds where you can lose some of your capital if the stock market falls dramatically.

On most you pay income tax on your gain, but with a few you pay capital gains tax instead which is usually more attractive to higher rate taxpayers.