Savings accounts are interest-paying bank accounts that help minimise the depreciation of your money from rising inflation.
What are savings accounts?
Savings accounts are a type of deposit account designed specifically for people wanting to save their money. The main feature they offer to entice customers is that they traditionally pay higher rates of interest than have been available from current accounts. However, to access the advantageous savings account interest rates consumers have had to forfeit some flexibility over using their money - at least in the short term. Saving accounts, unlike current accounts, do not offer customers chequebooks or debit cards, so the funds within them cannot be used directly to purchase goods or services.
How do I get the best interest savings account?
Although comparing savings accounts appears straightforward, there are a number of considerations which add to the complexity and should be fully understood prior to application.
With a couple of exemptions, savings accounts are fairly straightforward to compare. The rates of interest offered to customers are wrapped into a single comparable figure - the AER.
The AER, or Annual Equivalent Rate, differs from other rates of interest, such as the gross rate, because it includes interest which has been paid on previously earned interest, and therefore better demonstrates the compounding effect that saving over a sustained period can have. It also ensures that seemingly advantageous introductory savings rates do not conceal less attractive interest paid after the introductory period has expired.
The speed at which deposits can be accessed, and the size of any penalty for early access, is rightly of interest to many savers. The longer an individual can deposit their money, the higher the returns are generally likely to be. For instance, a 5 year fixed rate product will offer considerably more interest than instant access. However, if a saver were to need their money back before the full 5 years are complete, the penalty might be such that the effective AER would be made lower than comparable instant access accounts.
Minimum Opening Balance
Traditionally, when record keeping was more laborious, accounts with a higher minimum balance could pay higher interest because the overheads required to service the accounts were minimised relative to the deposit amount. Technology and automation has all but erased much of the physical requirement for higher depositors, but different accounts and account types still have their own thresholds, which should be considered and maximised wherever possible.
What different types of savings account are available?
To help simplify savers' opportunities and maximise their savings, different distinct product categories have been developed. Some instigated and overseen by government, others by convention and necessity to help comparison.
ISAs (Individual Savings Accounts) are a government initiated savings vehicle that protects savers deposits from income tax. Income tax in the UK is payable on almost all income, whether that comes from employment or investments. In effect, this means that interest accrued on savings deposits is taxable at standard income tax rates (20% - 45%) and deducted for HMRC before it's credited to a savers account.
ISAs are designed to encourage people to save for the future by offering shelter from tax to savers deposits. The amounts that can be paid into ISAs are prescribed every year by the government and should be checked to ensure that individuals maximise their savings potential.
Whilst central bank interest rates have remained at historically low levels, people who borrow have enjoyed years of cheap credit. However, this has largely been to the detriment of savers, who have seen interest rates slashed.
In response to declining interest rates and improvements in technology that have reduced the barriers to entry for new businesses wanting to enter the saving market, a number of new peer-to-peer saving businesses have entered the UK market.
The concept of Peer to Peer (or 'Social') lending is relatively straightforward and harks back to a traditional retail banking model. Savers offer deposits which the savings platform operators then use to fund loans to borrowers. The interest rates available to those borrowing are higher than the interest received by savers. The difference between the two rates covers the cost of platform overheads and delivers a profit margin.
Peer to Peer platforms claim to have an edge over traditional banks and building societies because they do not have the large work force, branch network and advertising costs etc. that traditional institutions must service. With lower overheads, they can pass a greater percentage of interest directly to savers. Whilst this is no doubt good for savers, when it works, these organisations are very new and therefore not subject to the same level of regulation that traditional banking institutions are. As such, they do not offer the government back deposit protection that traditional banks and building societies offer.
Fixed Term Savings
Customers willing to forgo access to their deposits for a longer period are usually able to achieve better returns than those who require the simplicity of instant access, by placing their money in a Fixed Term Savings Account or Savings Bond.
Though the interest available from these products looks very attractive, they are only really suitable for individuals who are confident that they will not need to access their funds until the account has matured. Early withdrawals tend to incur considerable penalties.
It is also worth noting that although the AERs available from these products are high, they are still subject to tax (of up to 45%) and therefore are not directly comparable with ISA products.
Instant Access Savings Accounts
Customers wanting the greatest deal of flexibility with their savings should opt to place their money in an instant access savings account.
Whilst the interest on these products is low versus some other forms of savings accounts, they do offer savers some protection against the corrosive effect that inflation has on savings. A number of well protected traditional savings institutions offer these types of products and customers can withdraw their deposits at will, without penalty.
Although not technically a savings product, as competition to acquire new current account customers has intensified, a number of current account suppliers have added attractive in-credit interest to their products since the introduction of the seven day switch.
If you are unlikely to be saving a great deal, and would like to retain the ability to access your funds instantly, these high interest current accounts can offer a great place to savings vehicle.
How are my savings protected?
The collapse of Northern Rock, Icesave and other such institutions at the start of the recession in the mid-2000's forced governments around the world to start to offer protection to personal savers deposits, to help avoid the 'runs' on banks that would be self-fulfilling in their destruction of the institution, regardless of its actual financial position.
In the UK this government protection took the form of the FSCS (Financial Service Compensation Scheme). This industry funded scheme protects individual customer deposits up to £75,000 for every organisation* they hold deposits with. From 30th January 2017 this limit was increased to £85,000.
Currently, this means that individuals with £100,000 placed in deposit at a single institution only have their first £85,000 protected, and could lose £15,000 if the organisation became insolvent. To mitigate these risks, customers are advised to split their deposits across a number of FSCS protected businesses*.
*Different brands do not necessarily mean different organisations, and therefore increased protection. Customers should check the Bank of England's list of banks - here - to ensure that each form they are depositing with is considered to be a distinct bank or building society.
The FSCS is not the only government backed deposit protection available to UK savers. Some other governments offer similar protections.
The 'Malta Depositor Compensation Scheme' protects deposits up to €100,000 and is managed by a Committee appointed by the Malta Financial Services Authority (MFSA).
The “Fonds de Garantie Dépôts et de Résolution” (which is the French deposit protection scheme) protects deposits up to €100,000 if the Autorité de Contrôle Prudentiel et de Résolution (ACPR), which is loosely translated as ‘Prudential Control Authority and Resolution’, determines savers deposits "unavailable" and pays out within 20 working days.
The “Entschädigungseinrichtung deutscher Banken” is the German deposit protection scheme. It is funded by members of the Federal association of German banks and currently protects deposits up to €100,000, but is planned to rise in steps to reach €437,500 from 1 January 2025.
There are many other government backed schemes and all tend to offer good protection, but savers should be aware of how exchange rate differences might impact the value of the protection. The Euro, for example, has declined in value against the pound by over 15% in two years. If an individual had therefore placed the maximum protected £100,000 into an account, 15% or more no longer qualifies for protection.
Whilst Peer to Peer lenders can offer good rates of interest, they might struggle to attract business from more prudent individuals who want the security of a recognised protection scheme. Of course Peer to Peer platforms have recognised this and, although they are unable to qualify for government schemes, have sought to address the issue by developing their own deposit protection schemes.
These schemes obviously mean that savers have greater protection than they might otherwise have, but there are still considerable risks and savers will need to decide whether these risks are acceptable to them on an individual basis, given that there is no failsafe protection.