How low-risk can you get?

Abigail Montrose

There are few things as attractive in the financial services as the word "guarantee". Its pulling power cannot be underestimated, as investors scour the market in search of high returns with little, if any, risk to their capital. But a closer look at what is actually being guaranteed often reveals a less attractive picture.

For one thing, it is crucial to know exactly what is being guaranteed. It is possible to buy guaranteed-income bonds, which offer a fixed rate of return over the life of the investment, usually five years. It is possible to buy guaranteed-growth bonds, which usually mean the income is rolled up into a single payment when the investment matures. And it is possible to get a guaranteed return linked to a stock market return. But inevitably you cannot have all three.

Guaranteed-income bonds (GIBs) issued by insurance companies are one of the few products to provide a set income without risk to your capital. You invest a lump sum for a fixed period of time, typically between one and 10 years, and in return you receive a fixed level of income over that period.

At the end of the term you get your money back in full, but you will not be protected against inflation or increases in interest rates, which usually accompany higher inflation rates.

GIBs are offered by a small band of insurance companies, including Abbey Life, AIG (also known as Alico), Black Horse, Consolidated Life (aka Financial Assurance), GAN Life, Generali, Pinnacle Assurance and Premium Life. Most of the big life companies do not offer GIBs because of their internal tax positions.

Investors have to decide how much they want to invest and for how long, and how often they want income, such as monthly or annually. You then need to look at what rates are on offer for your requirements and choose the best rate available. The best rates are offered on large amounts invested for longer periods of time on GIBs.

Once you see a rate of interest you are happy with you cannot afford to hang around, as rates can change overnight. Always check that the rate is still available before investing.

GIBs provide the security of knowing exactly how much income you are going to get, when you are going to get it and for what period of time. The interest rate you lock into is all-important as you cannot renegotiate the rate once you've signed up and there are stiff penalties for early withdrawals, if indeed you are allowed to withdraw your money early at all.

GIB rates are based on current interest rates, so with many economists now predicting interest rate rises in the near future GIBs have fallen out of favour. Investors are unwilling to lock into GIB rates now as they may be considerably more attractive in six or 12 months' time.

Many independent financial advisers are advising clients not to invest in a GIB for too long a period while the outlook for interest rates is this uncertain.

"Beyond three years, people need to be wary of long-term bonds. But with a lot of building societies offering such poor rates, GIBs at least offer a better return than the societies over three years," says Brian Dennehy, managing director of the IFA firm Dennehy, Weller & Co.

Graham Hooper, investment director of the independent adviser Chase De Vere, agrees but believes there are a few bonds offering particularly good rates at present that could tempt investors to tie up their money for longer.

"You need to be selective about the rate you want. There are a few good products available at the moment. Over five years you should be looking for 7 per cent a year," he says.

The best GIB rates currently available range between 4 per cent on a lump-sum investment for pounds 1,000 for one year, and 7.15 per cent for a minimum investment of pounds 10,000 over five-and-a-half years.

The rates quoted for GIBs are net rates as the insurance company has already paid the tax, so there is no basic rate tax to be paid by the policyholder. This makes GIBs an attractive option for basic-rate taxpayers.

But they are not suitable for 20 per cent taxpayers or non-taxpayers as the tax already paid by the insurance company is not reclaimable by the investor. If a GIB is paying an income of more than 5 per cent a year, higher-rate taxpayers need to check with the insurance company to find out whether they will have to pay any additional tax.