Santander launches inflation-linked savings bond

Santander has launched a bond that promises to beat rising prices. Here's how it stacks up against the competition.

I feel sorry for British savers, myself included. Since the global financial crash of 2007-2009, we have been battered by:

1. The Bank of England base rate being slashed to an all-time low of 0.5% a year, where it has remained since March 2009.
2. Increased taxes, with the top rate of tax rising to 50% from 40% (cut to 45% from April 2013).
3. Persistently high inflation – the increasing cost of living caused by rising prices.

This 'triple whammy' of troubles means that British savers now earn some of the lowest returns in history on their spare cash. What can we do to fight back again pathetic interest rates?

Apart from shopping around for top-paying best buy savings accounts, there's little else British savers can do to counteract the ultra-low base rate. As for tax, the best way to dodge 20%, 40% or 50% tax on your nest egg is to open a tax-free Cash ISA.

Guaranteed to beat inflation

When it comes to coping with the rising cost of living, one way to preserve the future buying power of your cash is to buy index-linked (inflation-linked) savings bonds. The yearly returns on offer from these fixed-term savings bonds are linked to inflation. So when the cost of living goes up, so too do the interest rates paid by these bonds.

For more than a decade, National Savings & Investments (NS&I) has been king of this savings sector. Its five-year Index-linked Savings Certificates provided a return above inflation, as measured by the Retail Prices Index (RPI). For example, a certificate offering RPI plus 0.5% is guaranteed to beat inflation by 0.5% a year.

Alas, these tax-free certificates became so popular than they were selling out with weeks of being launched, as well as distorting the entire UK savings market. As a result, NS&I has no Index-linked Savings Certificates on offer today, nor does its partner the Post Office.

Santander rides to the rescue

Now for the really bad news: there are only two inflation-busting savings bonds on the market right now, according to financial researchers Moneyfacts. Here they are:

Source: Moneyfacts

I'll start with the first inflation-linked bond, which Santander has just launched (on 6th June). This runs until 1st August 2018 and promises to pay 1.05 times the rise in the RPI, with a minimum payout of 17%.

So anyone with at least £500 to spare can invest in this bond for nearly six years and two months and be sure to beat inflation over this period. The minimum return works out at an Annual Equivalent Rate (AER) of 2.65%, which compounds up to 17% interest over the lifetime of this bond.

As for L&G's bond, it also requires a minimum deposit of £500, but matures on 22nd March 2017, which is about four years and nine and a half months away. Again, it guarantees to preserve the 'real' future value of your money by beating inflation. It pays out 100% of the growth in the RPI (plus your original deposit back), with a minimum payout of 16%. This minimum payout works out at an AER of 3.01%, which compounds up to 16% interest over the life of this bond.

Which is the better bond?

The Santander bond pays 1.05 times the future increase in inflation until 1st August 2018, while the L&G bond pays only the bare rise in inflation until 22nd March 2017. Hence, the Santander bond has an extra 5% kicker that boosts your return by an extra twentieth of the inflation increase.

The Santander bond pays a minimum 17% on maturity, versus a minimum return of 16% from L&G. Then again, on a yearly basis, this works out at 2.65% AER versus 3.01% AER, so L&G has the upper hand when inflation is low.

As these two bonds have different terms and maturity dates, they are not directly comparable. Even so, if inflation is high (and stays well above the Bank of England's target of 2% a year), then the Santander bond is likely to have the edge, thanks to its 105% multiplier. On the other hand, if inflation stays below 3% a year, then the L&G bond will emerge the winner.

The savings safety net

These savings bonds are deposit accounts, so they are covered by the Financial Services Compensation Scheme (FSCS). This government-backed safety net pays out 100% of the first £85,000 per person per institution. Note that the L&G bond is on deposit with the Royal Bank of Scotland and is therefore covered by RBS's banking licence. You can learn more about the FSCS in Are your savings safe with Santander?

In summary, savers wanting to improve the returns generated by their saving could do worse than stashing away some spare cash in these inflation-linked bonds. However, don't put in more than you can afford to squirrel away, as you must not touch this cash for five to six years!

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