Want a safe option? Lend to the Treasury

The attraction of National Savings is the very fact that they are so dependable. But cast-iron security comes at a price
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The Independent Online

National Savings are like support tights. You can be sure the various accounts will do their job, but most people would be reluctant to admit to owning them.

National Savings are like support tights. You can be sure the various accounts will do their job, but most people would be reluctant to admit to owning them.

The attraction of National Savings - the government-run savings scheme - for more cautious savers at least, is the very fact that they are so dependable. You are lending to the Treasury so your money is about as safe as it can be from misfortunes such as commercial collapse or individual fraud. But cast-iron security comes at a price - namely, that you are unlikely to earn headline rates of interest on it.

For the 30 million UK residents holding some kind of NS product that's an acceptable trade-off. And even if you're not particularly averse to risk, the tax-free NS products are well worth looking at, for higher-rate taxpayers in particular.

National Savings are players in the most obvious tax-free arena - that of cash mini ISAs and Tessa-only ISAs. It's a fiercely competitive field, though, and the NS ISAs are not table-toppers.

Indeed, at present they are not even able to compete under the same rules as commercially run ISAs: the Budget announcement that cash ISA limits are to be retained at £3,000 for the new tax year which started on 6 April (instead of being cut to just £1,000) cannot be implemented by NS until Parliament has approved the changes to the NS regulations. So until 27 May it's possible to deposit a maximum of £1000 in a NS cash ISA, which can be topped up to £3,000 after that date. If you want to save the full lump sum before then, you'll have to turn elsewhere.

That's no great loss, though. The current NS rate for cash mini ISAs and Tessa ISAs is 6.25 per cent, with instant access and a minimum deposit of £1 - roughly comparable with many other ISA rates, and better than some. But you could earn 7.25 per cent on a cash mini ISA at internet bank Smile, or 7.05 per cent from the Coventry Building Society. Both offer the same (CAT-standard) terms.

However, NS comes up trumps with tax-free opportunities in addition to the ISA allowance. There are several choices, including fixed interest and index-linked savings certificates, children's bonus bonds and premium bonds.

Savings Certificates vary in terms of the length of time they are held and what type of rate is offered; each variation is available as a separate "issue", paying a different interest rate. You can hold up to £10,000 in each issue, regardless of the tax year. Savings Certificates may be either two or five year investments, and either fixed rate or index-linked. Which you choose will depend on your view of what inflation's likely to do - if you think it's going to rise, then you should choose one of the index-linked issues which pay a variable rate to reflect inflation plus a low fixed additional rate.

The 3rd issue, which runs for two years, is paying 3.15 per cent plus inflation (2.3 per cent as of February 2000). The 17th issue (the five-year version) pays 2 per cent plus inflation. The two year fixed-rate version is paying 4.75 per cent and the five year fix pays 4.5 per cent.

Although these don't sound particularly spectacular beside the ISA rates available, they are markedly better than the standard taxable deposit account rates - which range between 6.25 and 7.05 per cent - especially for higher rate taxpayers who would pay 40 per cent on taxable savings. The most attractive package is the two year fix at 4.75 per cent, which equates to a hefty 7.9 per cent gross of tax at 40 per cent.

The index-linked 3rd issue is also competitive: 3.15 per cent tax free amounts to 3.94 per cent gross for basic rate taxpayers and 5.25 per cent for higher rate taxpayers. If you add on the 2.3 per cent index-linking then you're looking at the equivalent of 6.24 per cent at basic rate or 7.55 per cent at the higher rate.

Children's bonus bonds are worth considering if you want to build up a nest egg for the next generation. Unlike other investments they carry no tax liability for parents channelling money to their children. Moreover, even in the event that the children grow up, start earning and become taxpayers before they cash in their bonds, they won't be saddled with tax to pay.

Again, they run in issues, with a maximum investment of £1,000 per issue which is available in £25 units. A fixed interest rate (currently 3.5 per cent) is paid for five years, with a bonus (currently 12.84 per cent) on the fifth anniversary.

That averages out at 5.65 per cent if the bond is held for the full five year term. And it's possible, until the child reaches the age of 21, to roll the bond over into the current issue on maturity.

Premium bonds are a source of potential millionaire status for more than 23 million bond-holders in the UK. And Ernie the computer's tax-free monthly draw has been made rather more alluring in the last few weeks, with an increase in the monthly sum to be distributed - up from 3.75 per cent of the total pot to 4 per cent in May and 4.25 per cent in June. There will be more higher value prizes and almost double the number of £100 prizes to be won in June compared with May.

Do premium bonds count as "proper" investments, rather than a less glamorous version of the National Lottery?

Unlike the lottery, there's no risk to your capital - you can cash in a premium bond at any time. And with the odds of winning a prize in any one month at 20,000 to one as of June, a maximum investment of £20,000 would on average win 12 prizes a year, mostly worth £50 or £100. The likelihood of netting the £1 million jackpot, however, would remain slim ata 680,000 to one chance of the Big One.

They are not the investments for anyone looking for capital growth they can count on; but if you have more spare cash to tie up and are game for a gamble, there's interesting potential to rake in a decent sum of money.

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