Income ISA offers up to 7.60% pa paid quarterly
Inflation reached as high as 2.9% in August as reported by the Office for National Statistics (ONS). As a result, many individuals are looking for ways to receive more income to combat the effect of rising inflation.
The current crop of savings rates do not offer the interest required to match inflation, let alone beat it. This means that, unfortunately, if you have savings in an instant access account you are losing money in real terms.
If you want to get more from your capital and you are prepared to take on a bit more risk then you could explore the opportunities that Income ISA plans offer.
At the time of writing, the FTSE 100 Defensive Income Plan from Investec provides individuals with the opportunity to receive up to 7.50% interest even if the stock market drops by 40%.
The FTSE 100 Defensive Income Plan
Unlike current Fixed Rate cash ISAs, which offer up to 1.375% per year, the FTSE 100 Defensive Income Plan has the ability to potentially provide a 7.50% return on your capital for the entire eight year term. Although the plan is designed for eight years, it has the ability to mature early or ‘kick-out’ at the end of each year from year 2 onwards.
Conditional Capital Protection
The Defensive Income Plan differs from Fixed Rate Cash ISAs, as the plan is a capital at risk product. If you are uncertain about putting your capital at risk, then you should bear in mind that the plan comes with what is called ‘conditional capital protection’.
If the plan runs for the full eight years and the FTSE does not drop by 40% from its level at the start of the plan then the capital invested will be returned in full. However, it is important to note that if the FTSE does fall below 40% then the capital is reduced by 1% for every 1% fall of the index.
For example if the FTSE fell by 39% then the capital is not affected, but if the FTSE fell by 41% then the capital would be reduced by 41%.
FTSE 100 Index
The FTSE 100 Index (‘the index’ or ‘the FTSE’) is widely recognised as the proxy benchmark for most investors. Since the historical volatility of this stock market is familiar to many investors, they are in a better position to consider the pros and cons of the plan within the context of the underlying investment.
Although the income ISA is not an investment directly with the index, the plan is linked closely with the performance of the FTSE 100 Index. The plan is dependent on the FTSE, as both the income and the treatment of the initial capital will depend on whether the FTSE drops below a certain percentage.
Interest that may beat inflation
The Defensive Income Plan has the ability to provide three times the amount of interest that a Fixed Rate Cash ISA can. However, this is determined by how well the FTSE throughout the term of the plan.
The level of the FTSE is recorded at the start of the plan. This is the known as the starting value and it is the figure used to calculate whether the plan provides an income payment or not. It should be noted that the plan will be calculated by the level of the FTSE at the beginning of the plan not from the date that the capital is invested.
After every quarter, if the index is above 80% of the starting value then a 1.90% income payment is made. However, if the FTSE does fall below 80% of its starting value then no income payment is made.
For those who believe that the FTSE may fall more than 20% the plan may still be of some interest, as there is another option available. The FTSE 100 Defensive Income Plan’s second option potentially provides 5.75% per year provided that the FTSE does not fall more than 40%.
Eight year fixed term
The majority of Fixed Rate Cash ISAs available to the general public typically offer fixed terms from 1 to 5 years. To fully benefit from the interest rates, the capital in a Fixed Rate CASH ISA cannot be withdrawn during the fixed term.
Although the Defensive Income Plan has a fixed term of eight years, it is important to note that it is possible to withdraw the initial capital from the plan early. However, the plan was designed to run for the full eight years and if the capital is withdrawn before the term has concluded then the returned capital may be less than expected.
What makes the Defensive Income Plan stand out from the majority of other plans is its ability to ‘kick out’ or mature early. This means that the initially invested capital can be fully returned before the eight year term has concluded.
For the Defensive Income Plan to ‘kick out’, the FTSE has to show an annual increase of 5% or more from the second year onwards. Therefore, should the FTSE increase by this amount in the future, investors will receive a final income payment along with a full return of their initial capital.
Capital at risk
It is important to remember before considering the Defensive Income Plan that it is a capital at risk product and only those who are prepared to potentially lose some or all of their capital should invest in this plan.
The principle of risk versus reward means that the search for potentially higher returns leads us to consider putting our capital at risk. A good benchmark for assessing the merits of an investment is to compare what returns can be secured from a fixed rate deposit over a similar time frame (fixed income plus full capital protection), with the potential returns from the capital at risk product.
You can find more information in relation to the Defensive Income Plan here.