The Annual Equivalent Rate (AER) is the standard interest rate for comparing savings products and bank accounts in credit.
Note that the advertised rate for most bank accounts, savings and investments refers to gross interest – the ‘flat’ annual rate earned before tax and any charges have been deducted.
Gross interest does not take into account:
- Any fees, commission or charges
- Introductory bonuses
- The effects of compounding
- Income tax on earnings
Gross rates are therefore not the best measure of return on investment and can be confusing when comparing savings options, especially as some advertise annual gross rates whilst others quote quarterly or monthly rates e.g. an account advertising a higher annual rate might not be as good as another with a lower monthly rate, where monthly compounding generates more interest over the year.
See more on how the frequency of adding interest to an account affects the overall amount earned.
Annual Equivalent Rate (AER)
the Standardised Interest Rate for Savings
AER (Annual Equivalent Rate) shows a more accurate picture than the flat gross rate, because it takes more factors into account and is calculated in a standardised way, making it easier to compare different savings and bank accounts.
AER shows how much interest would be earned if money was left in an account for one year
AER is a yearly rate, expressed as a percentage of the original amount deposited (the principal).
If you deposited £1000 in a savings account for one year at 5% AER, you would earn £50 interest
Think of AER as how many pence you would earn for every pound you saved per year
At 5% AER, you earn 5p for each pound saved: 5p x 1000 = £50 a year
AER takes account of the interest rate %, as well as the effects of compounding and how often interest is paid – so you can easily compare savings where interest is added monthly, with accounts where interest is paid annually.
Note: Where interest is paid annually, AER can be the same as the gross rate, because interest is added only once at the end of the year. But if interest is paid monthly or quarterly, AER will include the interest compounded during the year, and will therefore be higher than the gross rate (which shows only the flat annual amount).
Some accounts offer an introductory bonus. The advertised gross rate would show only the bonus you earn at the outset. Where the deal last less than a year, AER reflects the bonus and also the lower rate that follows, to show a more accurate picture of the interest you would earn over the whole year.
AER includes any fees and charges e.g. if there’s a charge of 30 days’ interest for withdrawing money, this would be reflected in the AER calculation.
Comparing AERs gives you a general indication of which savings will give the best return, if you intend to keep your money in the account for a year.
Limitations of AER
AER provides the best general comparison, but you need to be aware of the following points:
Tax on interest
AER does not take account of any tax you might have to pay on the interest you earn. Most people won’t need to pay any tax on savings because of their tax-free Personal Savings Allowance, but high earners or big savers who exceed their allowance, will need to take account of tax when comparing savings options.
Don’t assume you will get the advertised AER
Banks and building societies often attract new savers with high interest rates, but may pay less to people who have had their savings account for a while. Providers must communicate the actual rate you will receive.
Review the AER regularly, because it could become less competitive over time. Switching accounts might give you a better return.
Find out more about AER: