PLEASE NOTE THIS ACCOUNT HAS NOW CLOSED
National Counties Building Society has just launched a second issue of its index-linked cash ISA, perhaps hoping to woo disappointed savers who missed out on buying National Savings Index-Linked Certificates before they were recently withdrawn from sale.
Is the Index-Linked Cash ISA (issue 2) a worthwhile alternative to Index-Linked Certificates?
On the plus side it’s tax-free and can protect your savings from inflation over the next five years (just like I-L Certificates). But there are differences that potentially make it less attractive, as we’ll see a little later.
The minimum balance is £5,100 and you can fund this via your cash ISA allowance for the current tax year (if not already used) or by transferring an existing cash ISA(s). The ISA is open to savers until 30 September 2010, but may close earlier if fully subscribed.
Once invested you can’t get your hands on the money until maturity on 1 October 2015, during which time you’ll receive a fixed return of 1% a year - worth £51 for every £1,000 you invest. On maturity you’ll also receive a bonus equal to the change in inflation (measured by the Retail Price Index - RPI) between August 2010 and August 2015.
To give you an idea of what you might receive on a £5,100 investment assuming August RPI is 223, let’s take a look at a few scenarios:
|August 2015 RPI||Initial investment||Fixed 1% Return||RPI Bonus||Total Return||Equivalent Annual Rate|
This all sounds pretty attractive, but there is a fundamental difference compared to I-L Certificates. Whereas the Certificates pay the inflation-linked bonus on each anniversary (i.e. based on annual movements in the RPI Index), the National Counties Index-Linked Cash ISA only pays this at maturity based on the RPI movement over the whole five year period.
So, to give an extreme example, suppose RPI rises by 4% in years 1, 2, 3 and 4 then falls massively in year 5 so that it’s back to its year 1 start level. With I-L Certificates you’d enjoy an RPI bonus in each of the first four years and no bonus in year 5, a total of 16%, whereas this cash ISA would pay no index-linked bonus (because RPI didn’t rise over the whole period).
If inflation consistently rises over the next five years this won’t be a problem. But if we endure a period of negative inflation (deflation) as some predict, the National Counties ISA could lose out versus I-L Certificates.
The other big difference is that you can’t withdraw money from this ISA until maturity, whereas I-L Certificates allow this, albeit with a reduction in the rate you receive.
Despite these drawbacks I think the National Counties Index-Linked Cash ISA is still an appealing idea if you’re happy to tie up money for five years as you’re guaranteed to beat inflation (as measured by RPI).
But as a period of deflation looks a fairly likely possibility at some point over the next five years I wouldn’t bet everything on this ISA. Maybe use it for a year’s worth of cash ISA allowance, but not as a home for transferring all your existing cash ISAs.
Also bear in mind that National Counties is not the biggest of building societies (it’s the 15th largest with £1.2 billion of assets – Nationwide has £190 billion) so probably a good idea to keep within Financial Services Compensation Scheme (FSCS) limits, currently £50,000 per person. I don’t expect National Counties to go bust but in these uncertain times it's good to be extra careful.