How to Choose Savings Accounts
There’s a huge array of savings products, but don’t just focus on the highest interest rate, because other factors relating to how you want to save and the sort of return you require, will help determine your most suitable savings solutions.
You also need to bear in mind how different accounts work – many apply rules on how often, or how much you can put in or take out, the length of time you can hold an account etc.
Most people choose a combination of savings products to meet their requirements.
- Then research relevant options; compare their interest rates ( ), but also take note of the terms and conditions!
Factors to Consider
How do you want to save?
Your choice of product will depend on your savings plan e.g. your goal, how much you can afford to put away and how often, whether you will need access to your cash and how you want to manage your account.
Interest payments – what sort of return do you require?
A decent interest rate will be a key decider, but there are additional points to consider:
- Be aware how tax (if applicable) and inflation can erode your return and how this might influence your choice of product.
- Are you looking for a guaranteed return or could you accept fluctuations in payments?
- How would you like your interest paid? Do you want some regular income or a lump sum?
- Know what interest rate you are being quoted, and what you will actually receive – so you can make a fair comparison between products. Is that introductory bonus as good as it looks?
Think about these questions, which are discussed in more detail below, to help identify the right type of savings account for you.
How do You Plan to Save?
Do you have a savings goal?
Do you need to save a specific amount within a certain time frame e.g. for a car or holiday?
If so, a Regular Savings account could be a good solution.
Savings Calculator – Money Advice Service
Work out how long or how much you need to save, to reach your savings goal
Regular or occasional savings?
Do you plan to put a little money away monthly, invest a lump sum, or just save at your own pace as and when you have spare cash?
How much money do you want to put away?
Some plans are designed to gradually build savings from frequent deposits of low amounts (e.g. Regular Savings accounts), whilst others are better for earning a good return on larger lump sum investments (e.g. Fixed Rate Bonds). Some accounts offer tiered rates – paying higher interest the greater your balance. Others impose lower or upper limits on the amount of money you can hold in the account.
Easy access or long-term savings?
There is usually a trade-off: easy access to your cash OR a higher return for locking money away.
So consider whether you will you need to dip into your savings. Or can you afford to tie up money without impact on your spending, and if so how much and for how long?
- Generally, the longer you lock away money, the better the return; Fixed Term accounts are usually 1-3 years. But you can’t usually withdraw cash during the term, or if you can, it may cost you a hefty penalty. Bear in mind if interest rates rise, you can’t just switch savings to a better deal.
- A possible compromise is a Notice Account – you retain access to your funds, but give notice prior to withdrawals (usually 30-120 days). In theory, Notice Accounts should pay a higher interest rate than standard Easy Access accounts, but do your research, because you might find a deal offering a decent rate with no access restrictions.
- If you prefer to retain total flexibility and get at your cash whenever you need it, consider an Easy Access savings account, or even a standard bank current account; some of these offer very competitive interest rates, so it pays to shop around.
Find out more:
Managing Your Account
How would you like to run your account? Do you prefer visiting a High Street branch, or do you want the flexibility of online banking?
Note some of the higher interest rate accounts are internet-only.
Choose carefully where you save:
Protection for savings
The recent collapse of Northern Rock, Royal Bank of Scotland, Icelandic banks and other financial institutions raise questions about what protection we have for our own savings, if the worst should happen.
All UK-regulated bank and building society accounts have protection under the Government’s Financial Services Compensation Scheme (FSCS) – up to £75,000 savings per person, per financial institution. So, if you have more than £75,000, consider spreading it between different banks and building societies.
BEWARE! If the interest rate looks too good, don’t be tempted!
The institution probably needs to attract money for some reason.
Most of the big banks and building societies tend to hover around the base rate and it is probably safer to stick with one of them.
Find out more:
Interest Payments – What Sort of Return do You Want?
This section looks at factors affecting interest payments and how your choice of product may be guided by whether you pay tax on savings, the effects of inflation, preference for a variable or fixed rate, introductory bonuses and how you want your interest paid.
Effects of Tax on Savings
Savings interest counts as income, which can therefore be liable to income tax; however changes to the tax rules in 2016, mean most people won’t need to pay any tax on their savings.
The introduction of the Personal Savings Allowance (PSA) enables most people to have a certain amount of savings interest tax-free e.g. basic rate (20%) taxpayers can earn up to £1000 interest before paying tax. They receive gross interest (no tax deducted).
Taxpayers can also benefit from Tax-free Savings Accounts e.g. ISAs (Individual Savings Accounts), premium bonds and some NS&I (National Savings & Investments) products. You keep all the interest, but it does not count towards your Personal Savings Allowance, because it is already tax-free; so you can earn additional tax-free interest on top of your allowance. A particularly attractive option for bigger savers and higher earners, these tax-efficient accounts can offer advantages for all savers.
If interest earned from standard accounts exceeds your Personal Savings Allowance, that income will be taxed at your normal tax rate, so you will receive net interest (gross interest less tax).
Comparison of interest rates – Taxable v tax-free savings
When weighing up options, remember that advertised gross rates and AER do not take account of tax on savings income, so be sure to compare the rates you would actually receive:
- Tax-free savings or taxable accounts below your PSA: you pay no tax and keep the gross interest – Compare AER
- Taxable accounts over your PSA: you pay your normal rate income tax, so you earn net interest – Compare AER less tax
For anyone who pays tax on savings income, tax-free savings can come out on top, even with lower interest rates.
Regular Taxable Savings v Tax-Free Savings:
Comparison of earnings for a basic rate taxpayer on £2000 savings over their Personal Savings Allowance
At first glance, a regular taxable savings account advertising 5% gross interest (£100) looks like a better deal than a tax-free Cash ISA paying 4.5% interest (£90).
But once 20% basic rate tax is deducted from gross interest, the regular savings account earns only 4% net interest (£80). So it is the tax-free ISA that gives the higher return of 4.5% (£90).
To compare a taxable account with tax-free savings, convert its gross to net:
Just multiply by 0.8
(Basic rate tax is 20% = 0.2, so net earnings are 80% = 0.8)
Find out more:
Income Tax on Savings & the Personal Savings Allowance:
Tax-free Savings Accounts:
Understand Interest Rates
What is interest and what factors affect the amount you earn
Effects of Inflation
Savings interest rate must be higher than the inflation rate.
If your savings don’t keep pace with inflation, you are effectively losing money (i.e. your savings will no longer buy the same amount of goods, because the goods will have become more expensive).
For the real value of your savings to grow, the net interest rate you earn must be higher than the rate of inflation.
Review regularly, particularly for long-term savings.
Variable or Fixed Rate
Do you want the guarantee of a fixed return, or are you prepared to accept the ups and downs from variable rate savings?
Some accounts offer a favourable fixed interest rate for a set period (usually 1-3 years). You will earn a guaranteed return, which can be helpful for budgeting or if you are saving for something specific.
Generally, the longer you lock away money, the better the return.
But the trade off is your money is tied up for that time – if interest rates rise, you can’t switch savings to a higher paying account. (If you are allowed to withdraw your money, you will probably be charged a hefty penalty).
Most savings accounts have variable interest rates, which can change at any time, fluctuating in line with the Bank of England base rate, or to compete in the market place.
Any change in interest rate will cause a corresponding rise or fall in regular interest payments, and will impact the growth of your savings. So monitor interest rates and consider switching accounts to maximise your return.
How Would You Like Interest Paid?
Regular income or lump sum?
Your savings will return a rate of interest monthly or annually; monthly interest can supplement your regular income, whereas a yearly payment may be suitable for long-term savings that mostly remain untouched.
Paid away or compounded?
Some accounts have savings interest ‘paid away’, which means it is paid into a different savings/bank account, rather than compounded along with your savings balance (i.e. if it is paid away, you will not have the benefit of your interest earning interest).
What Rate Will You Get?
Always check which rate providers are quoting, and exactly what you will receive – so you can make an accurate assessment of savings options.
The advertised rate for most products refers to gross interest, but the standardised AER (Annual Equivalent Rate) gives a fairer comparison between products: AER shows how much interest would be earned if savings were left in an account for one year.
Remember to look at net rates if you will be charged tax on savings income (i.e. on earnings over your Personal Savings Allowance).
Don’t assume you will get the advertised rate.
Banks and building societies often attract new savers with favourable introductory interest rates, but pay less to people who have had their savings account for a while.
Introductory Bonus Rates
You might be offered a favourable interest rate for an initial period, but before you are tempted, check out the deal.
It is fine to take advantage of introductory rates, but find out how long they last and what happens once the bonus ends; check that you could switch to a higher-paying account if the new rate is uncompetitive. Providers will not necessarily remind you when a deal is about to finish – note the date, so you avoid leaving savings on a rubbish lower rate.
Check the AER, which shows the interest earned over the whole year (reflecting the introductory bonus and also the lower rate that follows). The advertised gross rate shows only the bonus you would earn at the outset. AER lets you compare accounts with different introductory bonuses and those without.
However, if you plan to switch accounts once a short-term bonus ends, you will not be affected by the subsequent fall in interest rate; in this case, the gross rate earned during the bonus period is more relevant than the AER.
Find out more on Savings:
Savings Decision Tree – Money Supermarket
Q&A to help you identify the right type of savings account
Savings – Virgin Money
3 minute film