Fixed rate bonds and fixed rate ISAs: what’s the difference?

The key things you should know

Sarah Pennells – Virgin Money Living Mentor

by Sarah Pennells | Independent Money Mentor

Founder of SavvyWoman and award-winning journalist

Fixed rate savings accounts pay an interest rate that’s guaranteed not to change for a set time, and there are many advantages to saving in this type of account. But what’s the difference between a fixed rate bond and a fixed rate cash ISA? 

Here I explain the key differences between them so you’re in the know to choose the one that’s right for you.

Fixed rate savings accounts – the basics

With most savings accounts, the bank can increase or reduce the interest rate it pays. With a fixed rate savings account, it can’t. Instead, the interest rate is fixed for the term of the product – typically between one and five years. 

The bank normally pays the interest once a year, but – with some accounts – you can choose to have interest paid monthly. 

Who are fixed rate accounts for?

Fiixed rate savings accounts are often used by people who are either retired and therefore rely on the interest to supplement their pension, or by those who have a pot of savings already built up and they want to take advantage of a good interest rate. That’s because fixed rate accounts normally pay a higher rate of interest than you’d get on an easy access account. The longer the fixed rate period lasts, the higher the interest rate is likely to be.

For example, if a best buy easy access savings account pays 1.50% interest, you may be able to get up to 2.05% interest on one-year fixed rate savings accounts and up to 2.70% on five-year fixed rate savings. 

However, there are disadvantages to fixed rate accounts: 

  • You may not be able to take money out of a fixed rate savings account before the term is up – or if you can, you lose some of the interest.
  • You can only pay in money at the start of the term. Generally, you have a limited time after you open the account to pay money in (this varies between providers). After that, you can’t top it up. 

Fixed rate bonds and ISAs compared

I’ve talked about fixed rate savings accounts, but many banks and building societies call these savings accounts ‘fixed rate bonds’. The word bond has several meanings in relation to financial products, but in this case, it means a savings account that pays a fixed rate of interest. 

The main difference between fixed rate bonds and fixed rate cash ISAs is how the interest is treated for tax purposes and how much you can pay in each year:

  • With a fixed rate cash ISA, any interest you earn is tax free. With a fixed rate bond, interest is paid without tax being taken off. But, that doesn’t mean it’s tax free. Basic rate and higher rate taxpayers have a Personal Savings Allowance. That’s the amount of interest you can receive in a year without paying tax. If you’re a basic rate taxpayer, it’s £1,000 a year. If you’re a higher rate taxpayer, it’s £500. You have to pay tax on any interest you receive above this amount. 
  • There’s a limit on how much you can pay into a cash ISA each tax year. Your ISA allowance is currently £20,000 this tax year (2019/20). You can invest up to £20,000 in a stocks and shares ISA, or save up to £20,000 in a cash ISA, or split your £20,000 allowance between the two. With a fixed rate bond, individual banks will set limits on how much you can save into a particular product, but that’s down to them. It’s not set by UK-wide rules.
  • Fixed rate cash ISAs are more likely to let you take money out of the account before the term is up than fixed rate bonds – although you will have to forgo some interest.

Fixed rate bond or cash ISA?

Whether you choose a fixed rate bond or cash ISA will depend on:

  • How much you earn in interest from your savings. If you’re getting near to the £1,000 annual allowance threshold (or £500 if you’re a higher rate taxpayer), you may prefer a fixed rate cash ISA to ensure all the interest is tax free.
  • Whether you’re likely to need access to your money, which a fixed rate cash ISA is more likely to give you (usually subject to a charge).
  • Whether you want to invest more than the maximum allowance of £20,000 in a stocks and shares ISA. In that case, you should consider choosing a fixed rate bond. 

Some savers will find a fixed rate cash ISA is the right option; for others, it will be a fixed rate bond. But make sure you’ve weighed up the pros and cons before you open an account, as you could be locking your money away for several years.

You can find out more about how savings work, including fixed rate bonds and fixed rate ISAs, by watching this short video or reading the article The different types of savings accounts.

Before making financial decisions always do research, or talk to a financial adviser. Views are those of our mentors and customers and do not constitute financial advice.