02: National Savings certificates

National Savings fixed rate certificates (NSCs) allow a lump sum investment to be made and held for a fixed term of two or five years, with tax-free interest being added. Index-linked NSCs are available for terms of three and five years, offering an alternative to fixed rate returns by taking account of inflation in exchange for a lower guaranteed interest rate.

The interest accrued depends on how long the investment is held, with interest rates progressing over the term. This means there is a lower return if NSCs are cashed in before maturity. Ideally, certificates should be held for their full term.

The possible disadvantages of NSCs are that:

• They do not give an income. All the returns are rolled up and are only available, tax-free, at maturity.
• The rates of return, even if NSCs are held to maturity, may be less than those obtainable from other deposit accounts or similar investments. This is especially likely if the investor is a basic rate taxpayer.

Because the return is tax-free NSCs are mainly attractive for higher rate taxpayers, and the equivalent rate that would be earned in a taxable investment can be calculated by dividing by 0.6. Thus if the NSC interest rate is 3.0%, the gross rate to be earned elsewhere would need to be 5.0%.