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Personal Finance: Satisfaction guaranteed

For savers, the prospect of an interest-rate cut is perhaps not so welcome, but you can still get a good return on your investments with a guaranteed income bond
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You might think that what Bill Clinton gets up to in private is nothing to do with you. But when the President of the United States comes close to impeachment, the impact could well hit your pocket.

Why? In simple terms such a move could damage the world economy, hitting stock markets and eventually cutting the interest rates on even simple savings accounts.

Such incidents, and others such as the new German Chancellor and the Japanese banking collapse, mean long term interest rates are very difficult to predict. And with some experts forecasting that UK rates could fall to as low as 4 per cent after we join EMU, locking yourself into higher rates now could well be a wise decision.

An easy way to do so is through what are known as guaranteed income bonds (GIBs). Issued by insurance companies, these pay a fixed annual or monthly income net of tax for a set period, between one and five years normally. All capital, the cash you stump up at the beginning, is returned in full at the end of the term.

You'll need at least pounds 3,000 to invest, and the more you save, the better rate you'll be able to earn. Over one year, for instance, you'll currently be able to get 5.15 per cent annual income net for pounds 3,000, but 5.5 per cent for pounds 10,000 or more.

Compared to deposit account returns, the rates don't look that attractive at present. Accounts such as Cheltenham & Gloucester Instant Transfer and Safeway Direct Savings, for instance, are paying 6 per cent net on pounds 2,500 and pounds 1,000 respectively. But choosing the high-paying postal account may not be the best option over the year, says Brian Dennehy, an independent financial adviser based in Chislehurst, Kent.

"Although the rates on GIBs are beginning to look meagre on one year, you have to take a year long view," he says. "On that basis, some people are suggesting that base interest rates may be down by 1 per cent or more over the next 12 months. A guaranteed income bond will be paying the same amount throughout its period, but the building society rates are probably going to get a lot less exciting."

As the bonds are paid net of basic rate tax, they are not much good for non-taxpayers as the tax cannot be reclaimed. Higher rate taxpayers may also be hit, as they must pay the difference between basic rate and higher rate tax.

In fact they're not strictly bonds but life insurance policies. They allow you to choose a monthly or annual income, and so can be ideal for those needing a regular income who feel that interest rates are likely to fall in the future. The rates offered change almost daily and have been showing a downward trend for some time. But that simply reflects a growing unease in the direction of future interest rates.

Effectively, companies offering guaranteed income bonds have to predict the way rates will go. Anyone taking out a bond also has to gamble on interest rates, and hope that they don't end up locked up into a low rate. But that's the only real risk.

Unlike most stock market-linked investments, you won't lose your cash with a guaranteed income bond. The only real risk is that the insurance company issuing the bond goes bust, and in that case you would get back 90 per cent of your invested capital from the Policyholders' Protection Scheme, the insurance industry's compensation fund.

The bonds are offered by a number of smaller insurers, such as AIG Life, Pinnacle Insurance, and Wesleyan Insurance. Currently 12 companies offer the products, but others have dipped in and out of the market. The fact that you may not have heard of the companies issuing the bonds is simply because the bigger companies tend to avoid them for complicated tax reasons.

If you don't need an income, you could instead use the similar guaranteed growth bonds. These are effectively guaranteed income bonds, which reinvest all the income net of basic rate tax. The reinvested income is then paid out at the end of the investment period as as fixed amount of capital growth.

Currently deals work out at around 5 per cent a year, so over five years you would be looking at guaranteed growth of around 25-30 per cent. Compared to building society returns these too may look a little poor at present, but the position may well change over time as interest rates fall.

Of course, despite all the current predictions, there is no guarantee that interest rates will drop. Anyone planning to lock themselves into a fixed rate return now has to face up to the fact that it could be a mistake if rates actually rise.

Building Society Bonds

A NUMBER of building societies have issued what they call five- year guaranteed bonds but they are wholly different to the insurance company issued guaranteed income bonds.

With the building societies the guarantee just covers the capital, the original sum you invest, and sometimes not even that. the building society version of these bonds invest in the stock market and returns are linked to the performance of shares. It means that if markets fall you will get just your capital back.

One of the leading issuers of these guaranteed equity bonds is Bristol & West, which pioneered the idea in 1992. "Investors' cash is split into two parts," explains Simon Pratt, group product manager, investments, for B&W.

Around three quarters of the capital buys a zero coupon bond which guarantees the return of the capital in five years. The rest goes into buying derivatives.

These give the option of being sold if the market has performed well, otherwise the option simply lapses and there's no return of your cash.