Fixed-rate bonds appeal as Isa hike disappoints

The Budget increase in the individual savings account (Isa) allowance to £10,200 a year offers limited short-term benefits, say financial advisers.

Based on current low interest rates, the return from the extra £1,500 savers will be able to put into a cash Isa (up from £3,600 now) is equivalent to around just £30 a year. And while over-50s can use the extra allowance from October, everyone else will have to wait until the new tax year in April to take advantage of the higher limit.

But there are other ways to boost returns from savings at little or no risk.

While savings rates are generally at record lows, some non-Isa cash deals have improved and offer reasonable returns at a time of falling inflation and volatile stock markets.

The average instant-access account is paying less than 1 per cent, but the top fixed-rate bonds offer above 4 per cent.

West Bromwich Building Society has a one-year deal paying 4.3 per cent while for those prepared to tie up their money for five years, Chesham Building Society has just launched a bond paying 4.5 per cent.

More savers are also eligible to receive their interest gross, rather than with 20 per cent tax deducted at source. Individuals aged 65-74 who expect their total income to be £9,490 or less in 2009/10 can fill in an R85 form with their bank or building society to be paid the higher gross return. Those aged 75 and over have a slightly bigger personal allowance of £9,640 for determining whether they qualify, while the equivalent figure for the under-65s is £6,475.

HM Revenue & Customs is launching a “taxback” campaign to encourage older savers to apply for gross interest and reclaim overpaid tax. The Low Incomes Tax Reform Group (LITRG) estimates that hundreds of thousands of pensioners overpay tax on savings income because they do not know they can register to be paid gross or claim repayments.

In coming months, HMRC will write to more than 2m recipients of pension credit, a benefit aimed at retirees on low incomes, highlighting that they may be owed tax. Previous taxback campaigns have yielded average repayments of £200 for thousands of older people, said a spokesman, while the LITRG estimated that the latest exercise could produce rebates totalling tens of millions of pounds.

Spouses of the better off, who might have small pensions that they top up with savings income, could also be eligible for repayments of tax on interest, said John Whiting, tax partner of accountants Pricewaterhouse Coopers. And individuals with non-savings income of less than their personal allowance might qualify for rebates reflecting the little-known 10 per cent band for savings. While this lower rate was scrapped for most taxpayers last year, it is still available in some circumstances, and can be worth up to £244 in tax savings in 2009/10.

It is possible to reclaim overpaid tax going back up to six years by filling in an R40 form for each tax year.

But in spite of the limited value of the Isa increase in the short term, experts insist the tax shelter remains attractive, particularly for wealthier people.

Savers who have fully funded their cash Isas over the past decade could now have a total tax-free balance of about £55,000, including interest and cash from old-style Tessa accounts. Even at current rates, this could be giving tax-free interest of more than £1,000 annually.

Stock market Isas can also be used to produce higher tax-free incomes from corporate bond funds, albeit with some risk to capital. Yields of 5 per cent are available on lower-risk funds, says Hargreaves Lansdown, an investment adviser.