'Revolutionary' Santander savings bond pays interest UPFRONT (but beware the maths)

A 'revolutionary' new savings bond that pays interest upfront has been launched by Santander.

The Spanish bank has flipped the traditional savings model on its head: savers invest their cash for three years and get a 3.36 per cent return instantly. (2.69 per cent after basic rate tax)

Its left-field deal hits the High Street just a month after Halifax launched a similarly innovative, lottery-style £100,000 cash prize draw.

A little bonus: Santander pays interest upfront on an innovative new bond - but the three-year deal is a financially poor option, This is Money calculations show

A little bonus: Santander pays interest upfront on an innovative new bond - but the three-year deal is a financially poor option, This is Money calculations show

Santander's Upfront Interest three-year bond pales in comparison to the best deal on the market – Clydesdale Bank's 4.3 per cent – but the bank hopes to tempt savers with its quirky cash boon.

Someone depositing £12,000 today would receive £1,000 (after tax) on 2 December 2011 – just in time for Christmas shopping.

Making a splash: Santander has followed rival Halifax and its prize draw with innovation in the savings market

Making a splash: Santander has followed rival Halifax and its prize draw with innovation in the savings market

The catch? Customers need a Santander current account to qualify and must deposit at least £10,000, ruling out the account for vast numbers.

And in exchange for upfront returns, savers cannot withdraw their cash until 1 December 2014 under any circumstances.

Matt Hall, head of savings at Santander, says the account gives savers a boost 'at a time when we know they really need it'.

'We've approached our innovative new savings bond from a completely fresh angle,' he says.

'Obviously customers will be able to spend their upfront interest on whatever they like, maybe a holiday, Christmas shopping or even reinvest it to put it to work immediately.'

The bond term actually begins on 1 December 2011 – savers do not earn any interest beforehand.

The Spanish bank is launching a 'major' new TV advertising push featuring golfer Rory McIlroy to promote the product.

Beware the maths on this account

Dan Hyde

Dan Hyde, savings correspondent at This is Money, says: Wow. Santander really has plucked this idea out of left field.

Never before have I heard of a savings bond that pays interest at the beginning of the term.

The reason it's uncommon is fairly clear: it's less profitable for banks. Santander cannot use that return delivered upfront to fund mortgages or loans during the three-year term.

This is called 'opportunity cost' and explains why the interest rate is reduced; I can almost guarantee that other upfront products launched by Santander or competitors won't compete at the top of the savings tables, either.

But there is no denying this is an alluring product. As Santander's Matt Hall says, some will spend the cash on Christmas presents or a holiday. Other savvy savers will realise you can reinvest the cash to earn even more interest.

Calculator

But while this is truly innovative stuff from Santander – and should be commended because we need fresh thinking with the Bank of England base rate almost terminally stuck at 0.5 per cent – it's not necessarily a smart option.

Firstly, someone with £10,000 to deposit obviously has quite a bit of cash to play with; it's unlikely they'll be in desperate need of upfront returns with Christmas around the corner.

And crucially, a bit of simple maths shows up a serious flaw in this account. Those contemplating the merits of investing should read on carefully.

If you spend the cash

Take a £12,000 deposit, for example. Santander says a 20 per cent taxpayer gets £1,000 back right away. No further interest is earned and they give up access to their cash for three years. That gives a total of £13,000

If they plan to spend that £1,000 rather than save it, they are back down to £12,000.

However, if they spend the £1,000 out of their £12,000 capital instead and choose a better savings rate elsewhere they could actually boost their overall return.

That would leave £11,000, which could then be deposited in the best buy savings account – the 4.3 per cent at Clydesdale, which pays 3.44 per cent after basic rate tax.

Over the coming three years they'd earn £1,194 from Clydesdale (again, after basic rate tax). This puts the saver on £12,194.

That's an extra £194 just for steering clear of Santander and following the best buy tables.

If you save the cash

Just putting your £12,000 in a best buy Clydesdale bond would give a basic rate taxpayer £13,303 after three years and this simple act even beats the savvy saver's plan of reinvesting their upfront return.

If the saver re-invested the £1,000 earned upfront with Santander, they'd lose out. Savers can get 4.25 per cent with C&G on £1,000 (Clydesdale requires at least £2,000). That would earn someone £107 over the three years after tax.

Opt for reinvesting the Santander £1,000 interest and they would have a total of £13,107 - whereas simply take the Clydesdale 4.3 per cent bond and they would have £196 more with a total of £13,303.

Don't fall foul of Santander's new bond - it's a clever marketing trick.