Guide to savings accounts
Whether you are looking to build up a nest egg for the future or just for save for the next summer holiday, everyone could benefit from a good savings account. There are a number of different types of savings accounts on the market, but they all have the same aim – to help savings grow.
Most standard accounts allow customers to deposit cash into the account, which then earns interest at the rate specified by the bank or building society. The money that is sitting in the account is then used for mortgages and loans for other customers.
This is one of many reasons that the banks are keen to get big savers as customers. However, they aren’t always as transparent as they should be. What might seem like the best deal on the market could soon pay as little as 0.1% AER in a couple of months.
When choosing a savings account it is important that people are achieving good interest rates, but aren’t compromising on the features they require.
Types of accounts
Although all savings have the same goal, to generate as much money as possible, there are a number of different types. All customers have their own needs, and some may be willing to lock their money away for years, whereas others will want instant access.
Traditionally, when withdrawing money from a savings accounts, the account holder would have to give notice or receive a penalty. However, some savings accounts have slightly lower interest rates in return for instant access to the money. While the rates have gradually become more in line with notice accounts, the best rates are often found with online accounts.
For those that want to benefit from higher rates and avoid dipping into their savings, a notice account can be a good option. Customers will have to give warning of at least one month, but often up to three months, if they plan to withdraw any money. For instant access account holders will likely either have to pay a fee or put up with lower interest rates.
Customers that are fairly confident they won’t need to access their savings for a longer period can benefit from a term savings account. This means that the cash is locked up for a fixed term, usually between one to five years. In return to the customer, the banks often reward account holders with preferential interest rates.
Term accounts offer good rates, but they only work for people with a significant sum of money to lock away. Customers that want to start saving each month will prefer a regular savings account. When the account is opened, a fixed amount will be agreed. ISA Everyone is entitled to cash ISA, which offers tax-free savings. The annual allowance is currently £15,240 (for tax year 2016/17), so it is a good way for people to make a start on their savings. Just like any other savings account, it’s important to consider the interest rates and other features.
One of the most important things to consider when choosing a savings account is the rate of interest, as that is what will help a fund grow. The interest is represented as an Annual Equivalent Rate (AER) and will either be paid annually or monthly.
The first decision for savers is to decide between a fixed and variable rate. Unsurprisingly, the fixed rate remains the same, whereas a variable rate can fluctuate up and down – often in line with the Bank of England base rate.
There are pros and cons to both as if the fixed rate is higher than variable rates, savers will benefit. However, if variable rates start to rise above the fixed rate, they’ll lose out.
It’s also important that account holders find out what their actual AER is, as the rate advertised may vary between customers. The banks and building societies often reduce rates after a while, as the advertised rate is usually inflated with a bonus.
While the initial and advertised rates may be excellent, once the bonus has been taken off, account holders could be left earning paltry amounts with rates as low as 0.01%.
When savings start to earn interest, most customers will likely have to pay tax on any interest earned. The actual amount paid will depend on overall earnings, with basic rate tax payers paying 20% and higher rate 40%. Those that aren’t eligible to pay tax should be able to receive gross interest by completing an R85 form.
Due to interest being taxable, it’s important that savers make the most of their tax-free cash allowance. By depositing the maximum into cash ISA, account holders will be able to benefit from some tax-free savings. However, the annual limit is currently set at £15,240 (for tax year 2016/17), so any interest generated on savings over the threshold will be subject to tax.
How much to save?
In this instance there are some general guides to how much a person should be saving for their pension – if they are able to. The age someone starts their saving is important as savings build up over time, so to work out how much to invest, people should half the age they started their pension at. For example, someone starting at the age of 20 would only need to put away 10% – compared to someone at 44, who would need to stash away 22% for the rest of their working life.
Those just protecting themselves by saving for a rainy day should ideally aim for around 10% of gross monthly income. Should a person receive £2,208 each month – equivalent to the UK average salary – they should save at least £220.
For those that are unable to put away 10%, the second option is to work out disposable income (income minus expenditure). Anything that is left over once the necessary expenses have been paid should be put to one side for savings.
Consumers who have large amounts of outstanding debt are often better off repaying the debt than saving. This is because the interest rates on borrowing are much higher than that on savings, so they will benefit more by clearing debts – starting with the most expensive.