Over the coming months, anyone relying upon deposit interest payments to supplement their income will have to make some serious financial decisions.

Do you leave your cash with the bank or post office and watch the DIRT rate go up while the interest rate, your income, and the underlying capital values fall?

Or do you consider a riskier investment that will, at the very least, stabilise your return and ideally improve your capital base?

The advent of the European single currency means interest rates are likely to fall by as much as 2 per cent over the next year or so. In April of this year deposit interest retention tax on Special Savings Accounts goes up to 20 per cent. A new report from National Deposit Brokers, (NDB), shows the impact that falling interest rates and higher DIRT tax have and will continue to have on deposit incomes.

The report provides an historical example of a £100,000 SSA account taken out in April 1995 paying out 8 per cent over the first two years and 6 per cent over the final year. The DIRT rate over the period also changed from 10 to 15 per cent over the three years.

As the table shows, the after-tax income from that account dropped from £3,600 every six months to £3,400 and then to £2,550 amounting to a total income of £19,300 over the three years and a return of the £100,000 capital. But when inflation of 5.4 per cent over the period is taken into account, the adjusted, spending power value of the £100,000 three years later had fallen to £94,600.

NDB forecast that if the same depositor leaves their funds where they are until October 2000, their net, six-monthly income will continue to drop from £2,550, to £2,400 to £1,600 and their inflation adjusted capital will have dropped further in value to £87,978. Total income taken over the period is now £12,950. Similar tables are produced for An Post SSA accounts. By way of contrast and as a solution to this falling income problem NDB has shown how unit-linked distribution bonds have performed over the same periods. Little known, probably because only one company, New Ireland (now owned by Bank of Ireland Asset Management) currently offers them here in Ireland, a distribution bond is a unitlinked investment in very secure blue-chip shares such as the banks, CRH, Smurfit, etc, and in government bonds, also known as gilts.

Like a unit-linked fund, the capital is not guaranteed and the price of the units can rise and fall according to market performances. But unlike a conventional unit fund, the income from the bond is paid out in the form of a half-yearly dividend, based on the income the bond receives from the assets within the fund. Those assets the blue-chip shares and the government gilts are chosen because they produce high yields/dividends.

The upside of the distribution bond, says NDB, is that income and capital are separated and the dividends that are passed on have not affected the number of units continuing to be held within the fund.

Over the April 1995-October 1997 time frame, an equivalent distribution bond produced a net half-yearly income that actually went up steadily from £2,435 to £2,923. Total income taken was £16,067, about £3,000 less than the equivalent SSA over the period, but unlike the SSA, the actual capital would have increased by October 1997 to £127,833.

Once adjusted to take account of inflation over the period, the real value of the capital became £120,930. By contrast the £100,000 initial capital deposited in the SSA was now worth £94,600. It is impossible to predict how unit-linked funds will perform over the next three years, but NDB has assumed a 5 per cent capital growth rate. With £131,029 to invest (the amount that would be available by April 1998) in the distribution bond, half yearly net income would begin at £3,021 and steadily rise to £3,511 by October 2000 for a total net income £19,596 (as opposed to £12,950 for the equivalent SSA.) The capital is now worth £148,249, as opposed to £87,978 for the SSA.

It would be foolhardy to think that this kind of income or capital growth is achievable without risk. A steady drop in the stock market or gilt yields would eventually result in a fall in dividend payouts and the investor's income. A fall in share prices - at any time - will mean an equivalent fall in the underlying value of your capital.

This is not a product for anyone who watches the market and faints at the mere sight of a drop in prices. The capital value of this bond is going to fluctuate up and down all the time, but unless the downward movement is dramatic and sustained, it shouldn't have much of an impact on the dividend declared by the underlying companies or the gilt coupon (the gilt equivalent of a dividend). National Deposit Brokers believes the distribution bond is suited to mainly elderly and retired people whose aim is not to touch their capital, but to rely on it for their income. Ideally, such investors would have at least one other asset say, the family home

that could be relied upon if they were to need capital in the future, say to pay for nursing home expenses or long-term medical care.

Few financial advisers would suggest that all your capital go into a distribution bond.

Depending on the sums available, some financial advisers are able to secure higher deposit rates than those advertised by the financial institutions and this may be another way to boost deposit income.

There are also charges to be considered. The historical returns quoted for the distribution bond over the 1995-97 period are net of all taxes and charges, but this product does include a 5 per cent bid-offer spread and an annual management fee. Returns are made with the taxes already paid.

The distribution bond route is one to seriously consider since it has the potential to produce a much better income stream than wholly deposit-based accounts. But potential investors should seek out independent advice before making any decision, ideally from a fee-based adviser who will point out the risks as well as the advantages and try to come up with other options as well.

National Deposit Brokers has opened a freephone telephone line, 1 800 322422, for investors seeking a copy of the report.