All savings accounts have the same overall purpose, of trying to increase your money, by the payment of “interest”. Interest simply being the “reward”, for allowing the bank to look after and use your money.
Banks use your money by allowing other people to borrow it, either through loans for personal use, or for business activities, or through mortgages for buying property. The difference between the interest rates on the loans made, less a deduction for the bank's fees and costs, is what’s left for paying interest to savers.
Unfortunately for savers, but fortunately for borrowers, interest rates have been very low now for many years, and are likely to remain that way, for many more years to come. This means, that returns from savings accounts, will also be very low.
Easy access savings account
An easy access savings account should generally pay a higher rate of interest than a current account, whilst also giving you the flexibility to withdraw your money, as and when you need to, without penalty.
Advantages of using an easy access account
Add and withdraw money anytime, without notice or penalty
Easy to understand, manage, and set-up
Low cost to open
Disadvantages of using an easy access account
Flexibility usually means lower rates than other savings options
Easy access enables you to withdraw anytime, even if you want to save
There may be withdrawal restrictions on some easy access accounts
Notice period savings account
As its name suggests, a notice account requires you to ‘notify’ the savings provider in advance, every time you want to make a withdrawal. The theory is, that in return for this notice, you will get a higher rate of interest than you would do on a standard easy access savings account.
The shortest notice period available is usually 30 days, although some notice accounts can require, 60 days, 90 days, or even as much as 120 days’ notice. A few notice accounts, also restrict the number of withdrawals you can make in any one year.
Advantages of using a notice account
Restrictions on withdrawing money can help with saving discipline
Fairly easy to understand, manage, and set-up
Should provide higher interest rates than easy access accounts
Disadvantages of using a notice account
Not able to withdraw money in an emergency
There may be a higher level of entry deposit required
There may be withdrawal restrictions on some notice accounts
Regular savings account
A regular savings account, also known as a “monthly savings account”, is useful if you are able to regularly and reliably put money aside each month. Your money is paid in each month, usually by standing order, and depending on what product you have selected, the payments are likely to range from £10, up to a maximum of about £500.
When the 12-month term ends, these payments will stop, and the regular savings account will be converted into a normal savings account (no doubt paying much less interest). Regular saver accounts usually pay a much higher headline interest rate than other savings accounts, and so they can be very useful if you're saving for a special event like a holiday, wedding or a car.
Advantages of using a regular saver account
Interest rates are usually comparatively high
Good discipline for regular saving habit
Low set up and monthly saving costs from £10
Disadvantages of using a regular saver account
Not very useful for large savings deposits
Restrictions of £250 to £500 per month, limit the opportunity for growth
Usually also need to set up a current account with the provider
Also note, that your interest rate will drop if you miss a payment or take money out, so ensure you can keep it up for a full 12 months before you sign up.
Saving bonds are designed for longer-term savings with fixed lump sums. They are interest-paying deposit products, offered by banks and building societies, and also the Governments National Savings and Investments (NS&I).
These “bonds”, are essentially a fixed-term loan from you to the bank or NS&I (the bond issuer). Interest rates are usually higher than you would get from traditional deposit accounts, with the rates increasing in value the longer you tie your money up for.
The bond terms are usually, one year, three years or five years, with slightly higher interest rates attached to each bond the longer the duration.
Advantages of using a savings bond
Interest rates can be higher than other savings products
Good long term savings discipline as you cannot access your money
Easy to set up and understand
Savings bonds can take very high deposits
Disadvantages of using a savings bond
You cannot get your money out
If the fixed interest rate is lower than inflation, you will lose real value
A five-year bond is a long time to tie up your money
Make sure you understand the terms and conditions and any penalties of these products before you use them. Five years is a very long time to tie your money up if you cannot gain access to it. Some providers may allow you to make a withdrawal, within the term you signed up for, but you will be charged a penalty, usually in the form of forfeiting some interest on your savings.
Tax-free savings – ISA
An Individual Savings Account or (ISA), is a tax wrapper that shields interest on savings, (or gains on investments), from tax.
There is an annual cap on the amount you can contribute to ISAs each tax year, which is currently high enough for most people’s needs. ISAs can come in several forms, cash ISAs, stocks & shares ISAs, innovative ISAs, and lifetime ISAs.
Cash ISAs are simply savings accounts where the interest is not taxed, and it doesn’t count towards your personal savings allowance. Just like normal savings accounts, there are a variety of cash ISAs available, including instant access, regular savers, fixed-rate deals, and junior ISAs for the under 18s. The opening balance on most ISAs is also usually very low at just £1.
Cash ISAs can be transferred between providers, but you must make sure you follow the correct process, or you will lose the tax benefit.
Advantages of using a cash ISA
Any interest earned is tax-free
Any interest earned does not count towards your personal allowance
Easy to set up and understand
Generous annual allowance
Disadvantages of using a cash ISA
Interest rates may be lower than other savings options
Tax advantage of cash ISAs has reduced following savings allowance
Annual ISA allowance cannot be carried forward
The benefit of cash ISAs has been reduced in recent years, by a combination of low-interest rates, and increased tax-free savings allowances. Unless you have a significant lump sum to invest in a savings account, it is unlikely you will exceed your savings interest allowance.
Look for the AER rate, or Annual Equivalent Rate when savings are advertised, to make it easier to compare to other savings products.
Tax on savings
Since April 2016, most savers have been able to grow their savings tax-free, thanks to something called the 'personal savings allowance.' This allowance allows you to earn interest of up to £1,000 tax-free if you're a basic-rate taxpayer (20%), or £500 if you're a higher-rate taxpayer (40%). Additional rate taxpayers, don’t receive a personal savings allowance at all. This means, all interest from your savings will be paid to you gross, and tax will no longer be deducted by your bank or building society.
There is also another allowance called the 'savings starter rate' which is in addition to the personal savings allowance. This extra tax break is designed for people on low incomes, to pay either no tax or reduced tax on their savings. The current level of the savings starter rate allowance is £5,000, in addition to your personal tax allowance. Any tax that is due from savings, is collected via the self-assessment tax regime.
Security and FSCS protection
Even in a low interest rate environment, where returns on your money are painfully low, banks do at least provide somewhere safe for you to store your money. Firstly, it is not likely to get stolen or lost, which is a possibility with cash hidden at home.
Secondly, deposits made with most banks and savings providers in the UK, are protected by the Financial Services Compensation Scheme (FSCS).
This scheme currently guarantees up to £85,000 of your savings, in the unlikely event that your bank fails.
If you were lucky enough to have more than this amount, or when you do eventually reach such a sum, then you should put the excess into another bank with FSCS protection, to provide you with peace of mind, that all of your savings are fully protected.