Interest Payment Types - Choosing between fixed rate bonds

JohnRooney

Hi!

I'm looking to invest £20,000 in a fixed rate bond for two years and the two best I have found are offering 2.24% (Axis Bank) and 2.26% (Secure Trust Bank).

The reason for pause in just choosing STB for their higher rate is that it says interest is paid yearly whereas Axis pays 'on anniversary'. Now, I don't know if 'on anniversary' means yearly (I suspect it does), but if it doesn't and it is paid at the end of the two years, am I better off? If interest is paid yearly then I'm not earning interest on what I've accrued during the first 12 months during the second year.

If someone can help me identify the optimal choice, or explain what I need to be looking out for in terms of terminology, I'd be hugely grateful!

John

James145

Anniversary would be the anniversary of the account opening, so a year after you deposited the monies. Therefore, in this context anniversary and yearly mean the same thing, and will probably be on the same date.

However, to be 100% sure, you could always check with STB.

eskbanker

As per https://www.onlineaxisbankuk.co.uk/?pid=2, Axis gives the choice of interest "Paid Monthly, Quarterly, Annually or at Maturity".

Investec is also an option listed at https://www.moneysavingexpert.com/savings/savings-accounts-best-interest/#twoyearfixed with a rate in between the two you highlight.

I'm not sure what you mean by "If interest is paid yearly then I'm not earning interest on what I've accrued during the first 12 months during the second year", as the balance at the end of year one would include the first year's interest and therefore in year two you would earn interest on 102.2n% of your initial deposit.

As ever, in terms of comparing interest, the key figure to compare is the AER one, as this is a standardised like-for-like measure that takes compounding into account.

londoninvestor

eskbanker wrote: »

I'm not sure what you mean by "If interest is paid yearly then I'm not earning interest on what I've accrued during the first 12 months during the second year", as the balance at the end of year one would include the first year's interest and therefore in year two you would earn interest on 102.2n% of your initial deposit.

Per Axis Bank's T&Cs (see 28.10 here) the interest is paid back to the linked current account - it doesn't roll up within the fixed-term account.

However, Annual is still a better option than At Maturity. They both pay you 2.24%, but (say your deposit is £10k), the At Maturity option gives you £448 at the end, whereas Annual gives you £224 a year from now, and £224 at the end. So you can save that £224 somewhere else for a year and get some amount of interest on it.

(Btw it's strange that the At Maturity option shows gross 2.24% and AER 2.24% - I'd argue logically that for a gross rate of 2.24% over 2 years, paid at maturity, the AER is a smidgen less than 2.24%, but the definition of AER can be a little quirky, so Axis may not be wrong in quoting that.)

bowlhead99

londoninvestor wrote: »

Per Axis Bank's T&Cs (see 28.10 here) the interest is paid back to the linked current account - it doesn't roll up within the fixed-term account.

It will be paid to your linked account on the payment date, whether you selected quarterly, annually, at maturity etc. If you only want it paid at maturity, it will only be paid at maturity, and meanwhile it *will* "roll up within the fixed term account", because it's only going to get paid out of the account, upon maturity.

However, Annual is still a better option than At Maturity.

Only if you want to take out the interest and go and save/invest it elsewhere, rather than leaving it rolling up inside the product until maturity at 2.24%. You may not be able to find a better rate than 2.24%, or want the hassle of having to find somewhere to put it.

They both pay you 2.24%,but (say your deposit is £10k), the At Maturity option gives you £448 at the end, whereas Annual gives you £224 a year from now, and £224 at the end.

That's not how leaving it compounding at an annual equivalent rate until maturity works.

If you put £10k in at 2.24% in the annual-paying product, after a year you will get £224 cash payment, which will not be kept in the product; the product will still only have £10k principal and will earn another £224 after another year. So £448 total, plus whatever you earn on the £224 cash you received at the end of year one and might save somewhere elsewhere and competitive for year two.

Whereas if you put £10k in at 2.24% in the pay-at-maturity product, after a year the value will be worth £10224 and as it is a gross annual rate (and AER) of 2.24% you will continue to earn 2.24% on that £10224 during the course of the second year, so will get £10,453 at the end (the £10,224 earning about a fiver more for the second year than the £10,000 earned in the first year). With the 'pay me at maturity' option, you don't 'just' get £10448 at the end, because that wouldn't be giving you the full annual equivalent rate of 2.24%. Getting 4.48% after two years is only approximately 2.215% annual equivalent rate, which is less than what they are advertising. So you won't only get £448 at the end, you'll get £453.

So you can save that £224 somewhere else for a year and get some amount of interest on it.

But that isn't 'better' than leaving it in the product and earning 2.24% on it, because you don't know what you will get outside the product - it might be less than 2.24%.

(Btw it's strange that the At Maturity option shows gross 2.24% and AER 2.24% - I'd argue logically that for a gross rate of 2.24% over 2 years, paid at maturity, the AER is a smidgen less than 2.24%, but the definition of AER can be a little quirky, so Axis may not be wrong in quoting that.)

I think you might be confused over how it works.

With periods of less than a year (e.g. monthly or quarterly interest) the gross rate banks use is going to be less than 2.24% while still claiming an annual equivalent rate of 2.24%; because when they start putting the (slightly lower rate of) interest into your account you can start to earn interest on it and compound your money back up to an amount that is the equivalent of just getting the 2.24% at the end of each year.

But when the interest payment period of the account is one or more years they won't pay you a lower gross rate than the AER; because the gross rate is already a 'per year' annual measure. They will pay you that annual gross rate of 2.24%, compounding each year until they actually pay it (ie £10000 pays £10453)

If you go to the product summary box on their website for the 2-yr deposit (https://www.onlineaxisbankuk.co.uk/?pid=2) they give an example:
Interest rate 2.24%
Maturity Amount (on £1000): £1053.30

So if you choose the annual payment option, they'll give you £224 interest for the first year, you 'take the money and run' and put it somewhere else; you will only get another £224 from the product after the second year, so you better hope you put it somewhere good enough to earn at least a fiver, or you'll wish you had just kept it in the product until maturity and received £453 rather than £224 plus £224 plus [whatever you can earn in a year on £224 elsewhere]

londoninvestor

bowlhead99 wrote: »

If you go to the product summary box on their website for the 2-yr deposit (https://www.onlineaxisbankuk.co.uk/?pid=2) they give an example:
Interest rate 2.24%
Maturity Amount (on £1000): £1053.30

Thanks bowlhead, this convinces me that I was indeed confused! It must be as you say.

Out of interest, do you know if there are any products that do work like I thought this one did, i.e. the interest is credited in one lump at the end, with no intermediate payments accruing and compounding? They would be useful in some circumstances, e.g. your marginal tax rate will be lower in two years' time so you want to get all the interest at the end.

londoninvestor

Please either ignore or read in conjunction with bowlhead99's post above that corrects it!

londoninvestor wrote: »

Per Axis Bank's T&Cs (see 28.10 here) the interest is paid back to the linked current account - it doesn't roll up within the fixed-term account.

However, Annual is still a better option than At Maturity. They both pay you 2.24%, but (say your deposit is £10k), the At Maturity option gives you £448 at the end, whereas Annual gives you £224 a year from now, and £224 at the end. So you can save that £224 somewhere else for a year and get some amount of interest on it.

(Btw it's strange that the At Maturity option shows gross 2.24% and AER 2.24% - I'd argue logically that for a gross rate of 2.24% over 2 years, paid at maturity, the AER is a smidgen less than 2.24%, but the definition of AER can be a little quirky, so Axis may not be wrong in quoting that.)

bowlhead99

londoninvestor wrote: »

Out of interest, do you know if there are any products that do work like I thought this one did, i.e. the interest is credited in one lump at the end, with no intermediate payments accruing and compounding? They would be useful in some circumstances, e.g. your marginal tax rate will be lower in two years' time so you want to get all the interest at the end.

Now I'm really confused about whether you understand it or not...

If you select the "only pay me at maturity" option, you do only get paid in one lump at the end, with no intermediate payments. No tax is due until the end because no interest amounts have been made available to you until the end of the interest period (two years long). But you are still getting paid an annual equivalent rate of 2.24%, so the amount of money you get will be the same as if you had been credited with the 2.24% once per year and the grand total interest on that payment date will be £453 of interest not £448.

If instead you opt for the interest period to be only a year long or a quarter long or a month long, you would have interest income actually arriving in your linked account every [year / quarter / month] which you could save or invest elsewhere, but those receipts would be taxable income in the tax years they were made available to you.

When you say, are there any products that work like: "interest is credited in one lump at the end, with no intermediate payments", and "would be useful in some circumstances, e.g. your marginal tax rate will be lower in two years' time so you want to get all the interest at the end."... then yes, the "interest at maturity" version of this product seems to fit the bill.

If you are looking elsewhere for products, and want to be taxed only at the end, what you should be looking out for is a combination of "interest paid only on maturity" and "Premature Withdrawal: Not allowed". Per the link I gave above, this fixed deposit product has those features (if you select 'at maturity' rather than monthly, quarterly, yearly for the interest payment option).

londoninvestor

bowlhead99 wrote: »

Now I'm really confused about whether you understand it or not...

Yeah me too

Here's what's still confusing me.

If my principal is P, the gross rate on an account is R, and interest is paid every N months, then each interest payment should be P * R * N/12.

So for example, 1.2% gross on a £10,000 deposit, paid monthly, means P=10,000, R=1.2% and N=1, so I'd expect 10,000 * 1.2/100 * 1/12 = £10 interest in the first month.

Now, if for this account I get only one interest credit, after 24 months, and that payment is £453 per £10,000 initial deposit - that corresponds to a 2.24% AER, but why wouldn't the gross rate be quoted as 2.265%? (Since 10,000 * 2.265/100 * 24/12 = 10453).

This is where I think I'm still confused - I can only reconcile "Gross rate 2.24%, AER 2.24%" with a picture where one year's interest is credited (but not released) after a year, and so the second year's interest is 2.24% of the principal plus accrued interest.

londoninvestor

PS for some further context - we've discussed on a number of previous threads that if interest is credited annually, even if it's not paid until maturity, then it's taxable year by year as it's credited: illustration.

JohnRooney

Guys, thanks so much for your advice — really useful and helped clear it up for me :beer: