AA 5.15% 5 year bond withdrawal: some calculations

Porcupine

I nabbed an AA 5.15% account last week, but have been having slight second thoughts as to whether it's worth it based on the penalty charge and how long I'm going to leave money in there for. So, spreadsheet junkie that I am, I did some calculations.

The graph below compares the return you would get from the 5.15% account including withdrawal penalty, and compares it with the rate in an equivalent easy access account. What I do is assume you can get 3.3% in an easy access account for now, but at some time in the future there may be an account launched with a higher rate. The question is, how long do you have to wait to do that for it to be more worthwhile to put the money now in the AA fixed rate account? A 6% account is unlikely to be launched tomorrow, so how long do I have to wait for it to be worth my while hanging on in case?



As an example, let's see what happens if you keep money in for 20 months. Take a (virtual) ruler, and draw a vertical line from the '20' on the bottom axis. Now note the places it crosses the lines. For example, it crosses 5.4% at 8 months, which means you need 8 months at that rate to break even. In other words you need no more than 20-8=12 months before an account offering 5.4% is launched. Or 4.4% at 18 months, which means that a 4.4% account needs to be launched in 20-18=2 months for it to be worthwhile.

Similarly, keeping it in for 55 months is about equivalent to a 4.8% account being launched now or a 5.4% account launched in 10 months.

I'm afraid I haven't done the calculations including tax, but assume the results would be broadly similar. I've only done the calculations on a granularity of one month. I haven't run the spreadsheet for high rates (more than 5.4%) as I don't think they're too likely... but in general you can see that if such a rate comes along soon it's probably worthwhile leaving the AA account and switching to it - that calculation can be done at the time should it arise.

So what I learn from this is that, in my opinion looking at the timescales, it's actually fairly unlikely that an easy access account will be launched that will beat the AA account (unless we have serious inflation/interest rate problems).

Happy to run (easier) numbers through my spreadsheet if anyone is interested. Corrections, flaws in maths etc welcomed.

dougz_2

I am not instantly understanding what it is you are trying to achieve. Is the idea to use your bond as a substitute for an easy access account or something?

Porcupine

Essentially. I know I'm going to want to take the money out in less than 5 years. But I don't know when, so I can't even commit to a 1 year bond. It's unlikely to be in the next 9 months, but I can't say for sure (so if that happens I'm happy to pay a penalty for it).

So what I'm doing is speculating whether it's better to keep the money in the 5 year bond (and pay the penalty whenever I want it), or whether to take the top easy access account now and hope a better account comes along soon.

The results of calculations tell me that, unless a very good easy access account comes along very soon, I'm almost certainly going to win in the AA/BM account.

Porcupine

In case anyone wants to see the raw amounts, my spreadsheet is here:
aa-fixed-tidy.xls (550 KB)
(That's an export from OpenOffice, hope it looks OK in Excel)

Briefly, Sheet 2 (the first page) is the calculations. At the top are all the parameters. Column A is the time in the fixed rate account, and cols B/C/D are the capital in the FR a/c before penalty, the capital in the 3.3% easy access account and the capital in the FR a/c after penalty.

Cols F onwards are the amount you would get in the easy access account at 3.3% for (col A minus row 7) months plus the amount in the higher rate easy access account for (row 7) months. So cell M29 means 20-7=13 months at 3.3% plus 7 months at the higher rate.

Think I've set the higher rate in B4 to 3.2% (fairly meaningless), so you'll need to tweak this rate upwards for it to make sense.

Then col E is a function that says 'tell me the first month in this row of the grid that is greater than the value in col D'. I've copied this column for various values of B4 into Sheet 3 and that's what I plot.

If anyone spots any bugs I'd be really interested to know...

dougz_2

I am not sure about your penalty calculations:

a) 90 days is not exactly 3/12 of a year (column D)

b) I am not sure that they would compound the 'interest' for the penalty as you appear to. If not then the penalty is simply 5.03%*90/365=1.24%

c) Tax could make a big difference because, according to reports on here, the penalty is taken from your balance after taxation of the whole interest amount, and is not tax deductable. i.e for a 40% tax payer cashing in after 12 months they would only receive (5.15%*60%)-1.24%=1.85% net. This is equivalent to a gross rate of a mere 3.08% so they would have actually lost the equivalent of 2.07% in gross interest. For a 20% tax payer the figure would be 1.55%, and only for non-taxpayers it is still just the 1.24%.

Rollinghome

dougz wrote: »

c) Tax could make a big difference because, according to reports on here, the penalty is taken from your balance after taxation of the whole interest amount, and is not tax deductable. i.e for a 40% tax payer cashing in after 12 months they would only receive (5.15%*60%)-1.24%=1.85% net. This is equivalent to a gross rate of a mere 3.08% so they would have actually lost the equivalent of 2.07% in gross interest. For a 20% tax payer the figure would be 1.55%, and only for non-taxpayers it is still just the 1.24%.

Is anyone sure of that? I thought it was referred to as "90 days loss of interest". Surely, if someone paying tax at 20% earns £100 interest they pay £20 of tax? If they earn only £75 interest they pay only £15 tax. Or is it classed as a penalty charge?

dougz_2

AA call it a "charge" in their T&C, which sounds to me like another word for penalty, and something you wouldn't be able to recover tax from.
see http://www.theaa.com/savings/year_fixed_terms_oct09.html

Other threads on this include http://forums.moneysavingexpert.com/showthread.html?t=2009117

Maybe someone should call AA/BM and/or the tax people for a direct answer?

Rollinghome

The BM site says "Withdrawals are only allowed by post subject to a loss of 90 days interest on the amount withdrawn". So not saying "the equivalent of" or anything of that sort. Strange if they say differently on the AA site.

D1zzy

Rollinghome wrote: »

The BM site says "Withdrawals are only allowed by post subject to a loss of 90 days interest on the amount withdrawn". So not saying "the equivalent of" or anything of that sort. Strange if they say differently on the AA site.

Saga says the same - loss of interest.
Natwest says for theirs
Withdrawal penalty – no partial withdrawals are allowed. An early closure of the Bond will incur an early redemption fee equivalent to 90 days Gross interest.

I think all the ones I have had in the past have operated like Natwest - so maybe worth checking directly.

Porcupine

dougz wrote: »

I am not sure about your penalty calculations:

a) 90 days is not exactly 3/12 of a year (column D)

Fair point. That does affect things slightly. You have to bear in mind that I'm only taking the exact breakeven point, so a matter of pennies may push the point into the next month. That means the exact month numbers are very sensitive, but this isn't too meaningful - the difference in return is most likely to only be a few pounds, unless you're saving £100K+.

b) I am not sure that they would compound the 'interest' for the penalty as you appear to. If not then the penalty is simply 5.03%*90/365=1.24%

True, that's not clear. The difference on £100K is £6, which is fairly small. Again, it's just an indication and, again, so close to breakeven it's very sensitive. (I'm probably also running into numerical accuracy issues with doing lots of fractional powers)

c) Tax could make a big difference because, according to reports on here, the penalty is taken from your balance after taxation of the whole interest amount, and is not tax deductable. i.e for a 40% tax payer cashing in after 12 months they would only receive (5.15%*60%)-1.24%=1.85% net. This is equivalent to a gross rate of a mere 3.08% so they would have actually lost the equivalent of 2.07% in gross interest. For a 20% tax payer the figure would be 1.55%, and only for non-taxpayers it is still just the 1.24%.

That's a very good question. I think I'll give them a ring about that. (Forgot to post my cheque today. Oops)

dougz_2

Rollinghome wrote: »

The BM site says "Withdrawals are only allowed by post subject to a loss of 90 days interest on the amount withdrawn". So not saying "the equivalent of" or anything of that sort. Strange if they say differently on the AA site.

BM does also refer to it as a "charge" in their terms on page http://www.askbm.co.uk/savings/i/fixed/product.asp?id=283&p=terms

In any case, regardless of what the different banks happen to call it, I would have though the tax treatment would be consistent for what is basically the same situation i.e if you pay for something by forgoing income then you still get taxed as if you had received all the income?

I await with curiosity to hear what Porcupine gets told.