Savings accounts are ideal if you're saving for the short or medium term, under five years, or if you want a low-risk home for your money. Savings accounts generally pay higher interest rates than current accounts as they are deposit-based. This means you'll usually get back the money you have put in plus interest. The type of return (interest) that you receive often depends upon a number of factors: the duration that you will leave the savings untouched, how much notice you are prepared to give to get access to your money, how much you are prepared to deposit and how regularly you intend to pay in to the account. The complication for the novice saver is that accounts come with an array of differing features, benefits and protection. This can also be in addition to a number of restrictions placed on the account.
The type of savings account you choose is very much dependent upon your savings goal. If you're simply putting money aside to pay for household emergencies then you're going to want an account to give you easy access to your cash - it's no use waiting 90 days if the engine has just dropped out of your car. Likewise, if it's your children's university fees that you're saving for then having an account that you can't touch would seem like the perfect answer. Whatever your reason to put a little bit of money aside for there are an array of savings accounts on the market that will meet your needs. It's simply about finding the right one. Remember also that you don't have to save with the bank that holds your current account.
The basics - terminology explained
- Interest: 'Interest' is the money paid to you by the bank or building society for saving with them and is usually added monthly or yearly. This will make a difference to your outcome because the more often interest is paid or credited, the higher the effective return. It's obvious when you think about it because the more often interest is paid in to your account - the quicker you earn interest on your interest. The term for this is 'compounding' or 'compound interest'.
- Tax: The banks normally take income tax off before you receive it and it's a legal requirement for it to be deducted by the banks and building societies from your interest. The only time for concern is if you are a higher rate tax payer, a non-taxpayer or on a low income. This is because Income Tax is normally deducted at 20%, but if you're a higher rate tax payer or additional rate tax payer you'll need to inform the tax office that you owe tax on the difference. If you're a non-taxpayer you will need to arrange with the bank for the tax to be paid gross (meaning before tax). In order to do this you need to request and complete an R85 form. These are usually available from your building society or bank but are also held at HM Revenue & Customs online here. If you're on a low income - you may be able to claim tax back.
- Inflation: Be aware of the impact of inflation. Inflation occurs when prices rise throughout the economy. The effect of inflation means that the money you save will buy less each year. In order to protect your savings against this - look out for after-tax interests rates that are higher than the rate of inflation.
- AER: AER stands for annual equivalent rate. It lets you compare interest rates across saving accounts and reflects not just the amount of interest but also how often it is paid. AER is good news for us, the consumer, because the calculation is standard across financial institutions and makes it impossible to sway the results giving better visibility to the best savings accounts. Generally speaking, the higher the AER, the greater the return. For example, two saving accounts are advertising that they pay 5% a year but one credits all the interest at the end of the year and the other pays you 2.5% every six months. If investing £1,000, by the end of the year the second account will have grown slightly more than the first. This is because the interest credited after six months in the first account has itself earned interest during the second six months, increasing the return. Therefore the AER for the second account will be ever-so slightly higher than the first.
Types of savings accounts
- Instant Access or Deposit Account: An Instant Access account does exactly what it says on the tin - it lets you have access to your savings as and when you need it. It's the most common of all savings accounts and differs from a current account in that it usually pays a slightly higher interest, doesn't come with a cheque book and isn't expecting to receive your monthly pay cheque. Instant Access accounts are probably best served for the shortest of savings goals (holidays, Christmas, birthdays) - they're easy to manage, you can usually save as little or as much as you like and you can get to your money as and when you need to. Some Instant Access accounts come with a cashcard so that you can use it in the hole-in-the-wall. Always remember that you don't have to use the same bank as the one that holds your current account - it's still worth shopping around for the best deal. Compare the latest instant access accounts here.
- Fixed Notice: A Fixed Notice account works in a similar way to a standard instant access account except that you will have to give notice when you want to withdraw your money. The notice depends on the terms of the account - it can often be 30, 60 or 90 days. What you lose in flexibility, you often gain in better interest rates. You can normally save as little or as much as you want. If you have an emergency and need your money urgently, you can still access it without notice, but you will forfeit some of the interest. If you have a habit of dipping in to your usual savings account on a regular basis - a fixed notice account may be just the account you need to make you think twice.
- ISA: ISAs (Individual Savings Accounts) are tax free savings accounts which mean you do not have to declare any income from them. You may currently save up to £11,280 each tax year with a maximum of £5,640 deposited in to cash ISA per year (the rest being in a stocks & shares ISA). From 6 April 2013 the ISA limits will be increased in line with the Retail Prices Index on an annual basis. To pay in to an ISA you must be a resident in the UK, a Crown employee (such as a diplomat or member of the armed forces), you will also need to be sixteen or over for a cash ISA or 18 or over for a stocks and shares ISA. Compare the latest ISA rates here.
- Fixed-rate Bond (term accounts): You usually have to leave your money in for one year or more (the term). There is often a minimum deposit e.g. £1,000. You may find difficulty or you could receive a penalty if you withdraw during the term. Fixed rate savings accounts give you a fixed rate of interest on your money, paid for a fixed length of time. The best fixed rate accounts do tend to have higher interest rates than the best variable rate savings accounts, but you do take the risk that having locked your money away, you can't then get at it if rates start going up. However, if you like the certainty of knowing what interest rate your money is getting, then a fixed rate account could be for you. Compare the latest fixed rate bonds here.
- High Interest regular savings: These accounts are ideal if you are happy to commit to a regular monthly savings amount - which for some accounts can be as little as £5. They have been created to stimulate people in to habitually saving. Often the bank that holds your current account can offer a slightly higher rate of interest if you set up a standing order or direct debit to pay the money in each month and an annual bonus. There may be penalties however if you stop paying in regularly so it is vital that if you do decide to opt for this kind of savings scheme - you are able to commit to the agreed savings amount. Usually, interest is only paid yearly, and you can only withdraw yearly and there is usually an upper limit as to how much you can pay in (which is why the providers can offer a higher rate).
- Offshore Savings: Offshore savings offer a range of options, many of which are not available to standard savings accounts. Interest on offshore accounts is paid gross without any tax deductions and therefore can be very appealing. Offshore savings accounts can generally be accessed by the standard methods including online. Some offshore financial institutions are not covered by the UK Financial Services Compensation Scheme so do ensure that you check first (see below). Compare the latest offshore savings rates here.
Firms not based in the UK
It's a legal requirement for most financial services to have authorisation from the Financial Services Authority (FSA) before they are able to do business in the UK. The Financial Services Authority holds a register of all firms that are authorised in the UK. The register also holds details of those that conduct business in the UK that have been authorised in another European Economic Area (EEA). It's imperative that you look in to the complaints/compensation arrangements from the firm or its UK branch because the position may well differ compared to a UK authorised business. Firms authorised by another EEA should also be able to provide details of the extent of their regulation by the FSA in the UK.
Put off completely by the Banks?
The main types of saving products are obviously held by the bank and building societies however if you are extremely cautious after the seeing collapse of a number of financial institutions in recent times then there is also the state-owned National Savings and Investments (NS&I). Another alternative, which has become increasingly popular in recent years, would be to put your money in to a credit union savings account. Credit Unions are community run savings schemes (with the union sometimes loaning money too) where members pool their money. Members are linked by a common bond which maybe working for the same employer, being part of the same union, church or other association. Of course, there are many other short term options offering informal saving schemes from your local supermarket, social club or even pub but remember that typically - you will not earn any interest on your money (your money won't grow) and there is always a risk that if the scheme collapses you could completely lose your money. The FSA does not regulate Christmas hamper schemes or other Christmas savings schemes and clubs, therefore if the scheme does go 'belly-up' they will not be covered by the Financial Ombudsman Service or the FSCS.
To compare savings accounts from the UK's leading providers click here.
Author: KYM Editor
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