July continues to be a sorry month for savers, with the average interest rates on easy access ISAs falling to a meagre 0.37% and the average rate for a one-year fixed rate ISA is 0.61%. Those savers looking to invest tax-free with the potential of a better return while protecting their capital could consider a structured deposit. For those happy with some risk then a stocks and shares ISA could be an alternative way to invest.
Structured deposits are a form of deposit that pay a set rate of interest based on the performance of a stock market index, such as the FTSE 100. Savers can use these in the form of an ISA to ensure the interest they earn is tax-free. The requirements for each structured deposit are set out in advance, with some requiring the stock market index to rise in order to pay interest, while others allow for declines while still paying interest to savers. The advertised interest rates are higher than available from fixed term savings accounts, with Investec Bank offering structured deposit rates from 1.68% up to 3.3% per annum (not compounded). However, unlike a fixed term bond where the interest is guaranteed, a structured deposit may not pay any interest at all if the stock market index does not perform to the required level. Savers’ worst-case scenario is that the structured deposit will only return their deposit back at the end of the term.
A stocks and shares ISA is another way for savers to grow their investments tax-free. Unlike a structured deposit, savers will find their capital can be eroded if the stock market does not perform. The return savers can achieve from a stocks and shares ISA is volatile since stock markets can rise and fall. For example, the growth in the stock market during the 2019/20 tax year fell by 13%, but the new 2020/21 tax year has seen this increase by 15%. The returns achieved in 2018/19 were 4.04%, ahead of the average return from a cash ISA, but in 2019/20, stocks and shares ISA generated an average loss of 13.3%. Savers need to consider investing in stocks and shares ISAs as a long-term investment to help smooth out the peaks and troughs of their returns.
Structured deposit ISAs allow you to transfer money held in a stocks and shares ISA or cash ISA without losing their tax-free status. However, savers should check and understand any fees or penalties involved in transferring their existing ISA. Savers can add their annual ISA allowance of £20,000 at the point of opening their structured deposit. It is not allowed to add extra funds into your structured deposit in later years, so savers will need to deposit their future years’ subscriptions into either a new structured deposit or alternative accounts. Savers can transfer both stocks and shares ISAs and cash ISAs into a structured deposit.
When opening a structured deposit, your financial adviser or your online broker will provide you with the relevant transfer and application forms. The bank that operates the structured deposit will then organise the ISA transfer for you.
Read our guide to how to transfer an ISA for more information about this process.
Savers should be careful not to confuse structured products with structured deposits. Structured products will place your capital at risk, so if the stock market does not perform as required, you may find you get less back than you paid in. Structured deposits will protect your capital from falls in the stock market and will return at least your original deposit. They are also covered by the Financial Services Compensation Scheme (FSCS) up to £85,000 per person – the same as a savings account held with a bank or building society and subject to the FSCS eligibility rules.
Structured deposits are not available directly from the banks; savers must use a financial adviser or a specialist online broker. When opening a structured deposit with a financial adviser, savers will receive advice about how suitable these products are for them and any other alternatives. However, this advice may incur a fee. Alternatively, an online broker allows a convenient method to open a structured deposit, but this is on an execution-only basis, meaning all the risk of the investment decision rests with the saver. These brokers may also charge a fee for their service.
Our guide six reasons to speak to an adviser about structured deposits explains more about the benefits of using a financial adviser.
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