Reaping the reward of long-term saving

Try bonds, for a better rate of interest

Savings accounts are not the only place where your cash is safe, and can earn interest. For those prepared to lock up their money for a year or more, the banks offer a whole range of fixed-term bonds that often pay better rates of interest than their standard savings accounts.

The two main types of bond are fixed-rate and variable-rate. Generally, the longer you are prepared to tie up your money, the better the rate of interest you can expect. So a five-year bond is likely to pay more interest than a two-year one. Many have tiered rates of interest, so the more you invest, the more your money earns. For example, Bradford & Bingley's one-year Mutual bond pays 5.65 per cent on the minimum investment of pounds 500, but this rise to 6.15 per cent if you invest pounds 5,000, and to 6.4 per cent on pounds 10,000 or more.

With a fixed-rate bond the interest is fixed at the outset. Some bonds will pay out interest monthly, but the rates tend to be lower than if interest is paid out once a year. The advantage is that you know exactly how much you are going to receive during the life of the bond, so whether rates rise or fall over the life of the bond, your earnings will not change.

With a fixed-term, variable-rate bond, you put a set amount into the bond for a fixed period. During that time the interest will vary, but it is usually higher than the bank or building society's standard rate of interest. If rates rise during the term, so will your income, and vice versa.

Currently, there is more demand for variable-rate bonds than for fixed- rate bonds, says Rebecca Weston, of the Bristol & West Building Society.

"People think interest rates will rise over the next year, and so are preferring variable rate bonds to fixed rate bonds at present," she says.

A number of banks and building societies also offer "escalator" or step- up bonds that pay out a rising level of income over the term of the bond. One of the best-paying bonds at present is Sun Banking Corporation's Accelerator Bond. This five-year bond, which requires a minimum investment of pounds 5,000, currently pays out 5.5 per cent in year one, 6 per cent in year two, 7 per cent in year three, 8.5 per cent in year four and 10.5 per cent in year five.

Building societies used to confer membership rights on people who invested in their bonds. However, many no longer do this, because of the rush to join societies to benefit from any potential windfall. The Bradford & Bingley still offers membership with its bond, but Nationwide Building Society will sell its bonds only to existing customers.

Bonds are taxed internally, so if you are a standard-rate taxpayer there is no tax to pay on the interest the bank or building society gives you. But higher rate taxpayers may have a tax liability.

A number of banks, including Barclays, Lloyds, NatWest and TSB, also offer bonds which are linked to the performance of the stock market. These types of bonds are also available from a handful of building societies, including Birmingham Midshires, Bristol & West, and Britannia and Nationwide. The bonds are typically for five or six years and the amount of interest you receive is usually a percentage of the growth in the FTSE index; you also get your original investment back.

Bond issues are usually limited, so if you see a bond which interests you, find out about it straightaway. But before signing up, make sure you are happy with the terms; you will be locking your money away for some timen