Savings accounts guide
Saving is your ticket to financial freedom and security. No matter how small the amount you are able to put away, frequency is key - saving little and often will build up a tidy sum over time. This will give you the upper hand if you are ever faced with the unexpected, it can cushion you from all the nasties that life sometimes throws at us, and it will let you take advantage of once in a lifetime opportunities. In a nutshell, saving helps make money your slave, not your master!
The ins and outs of saving to help you know where to start
Saving is essentially storing your money away in a savings account with a bank or a building society and watching it build up interest over time. When you save, the amount in your account is safe, and the more you put in the more interest you are paid. Saving differs from investing however, because investing involves some form of risk, so your funds may go down as well as up. This will never happen when you save.
But there’s even more good news, as the longer you save the more your savings will start to snowball. Because you always earn interest on your capital, you’ll start to earn interest on your interest, then interest on your interest’s interest. This is called compound interest and over time will see your savings skyrocket.
The bad news when it comes to saving is that unless all of your savings are in a tax-free Individual Savings Account (ISA), the Government will tax you on all of the interest that your savings earn. Gross interest is the interest earned by your savings before the deduction of tax, and Net interest is all the interest earned after. If you are a non-taxpayer you can still have a savings account. Picking a savings account with a bigger gross rate of interest will see your funds get a bigger return.
However, it is also worth considering what the annual equivalent rate (AER)of the account is. The AER shows you the true rate of interest on your savings you will have received by the end of the year, taking into account how often interest is paid on your funds. You could choose to have your interest paid annually or monthly for example.
Looking at the account’s AER is also the best way of measuring how good a savings account really is, especially if you are looking at multiple accounts. This is because it can remove the effect that any promotional offers have when the rate drops after a few months, something that many banks and building societies are known to do.
Before you begin
- Review your finances first with our budget planner. If you have any debts it’s always important that you pay them off before you start to save because the cost to you if you are overdrawn, or have a large sum to pay off on a credit card, can far exceed the benefits that any savings will bring.
- Only save what you can afford! Don’t put yourself in financial difficulty by committing to a savings account you can’t afford to keep up, or neglect paying for the essentials.
- For variable savings accounts, there’s not much difference in interest for instant access and notice accounts. In some instances the best rates can be found with instant access, particularly online.
- For fixed rate savings, the rates are higher for notice accounts. However, you’ll have to be prepared to lock your money away for a certain amount of time. This is usually years than days or weeks.
- When you are ready to start saving, you need to consider what you want from a savings account:
Do you want instant access or would you like to lock away your money for a set amount of time?
- Do you want to put your money away regularly, or would you prefer to save a lump sum?
- There are many different savings accounts available, all with varying terms and conditions, so read our savings accounts guides to get a better idea of the savings market.
What savings account is best for you?
- Whilst everyone’s financial situation is different. You should always have instant access to some of your funds for any emergencies.
- If you are a taxpayer, opening up an ISA should be your first port of call because all the interest paid to you will be tax-free. You can either pay up to £3,600 each tax year into a cash ISA, or up to £7,200 in a stocks and shares ISA. The tax year runs from 6 April to 5 April, so it’s very important that you try to make the most of your yearly allowance.
- Once you have used up your ISA allowance, for the highest rate of interest you should consider opening up a regular savings account. These will always require a monthly payment into the account, and this can vary from £1 up to £2,000. Unfortunately, because you cannot invest lump sums into regular savings accounts as and when you want, you will need to sustain the account regularly. A monthly standing order can be set up easily for this.
- For greater flexibility, or if you find you have more funds spare to put away, think about opening a standard savings account.
Whilst this is a basic guideline for saving, there are other accounts available which also have their own merits. Other options include:
- Monthly interest – for savers who want to supplement their monthly income on their investments.
- Fixed rate – for savers who want to receive a higher rate of interest but are prepared to lock away their funds for a certain amount of time.
- Internet-based accounts – Generally offer the best return for savers who want to bank online
- No notice – for savers who need quick access to their funds, this is generally 3 working days
And what to avoid…
Some savings accounts are not always what they seem, and come with some pretty harsh punishments if you break their complicated terms and conditions. Follow our savings checklist and you’ll avoid some of the more common tricks of the trade that many banks and building societies use.
- Always watch out for headline grabbing interest rates. These often include temporary bonus rates that disappear after a period of time. If there is a bonus rate involved, check how long it’s for and make a note in your diary to switch if you can.
- Check whether the rate is fixed or variable. If your rate is fixed then you’ll received a guaranteed return, but you may not be able to get to your money without a penalty. For variable rates, you’ll be able to get at your money, but remember your return can do down as well as up.
- Compare AERs over the whole year, some accounts could prove to be better deals even if they don’t have an introductory bonus.
- Always look behind the headline rate – you may be forced to open a separate product with the bank or building society to get it, such as a current account or a life product.
- Keep an eye on our savings best buy tables to see how your account compares with other savings accounts out there.
- You may be limited with the amount of withdrawals you can make, and some accounts will not pay you interest if you make withdrawals.
- Some accounts will tie your funds up for an amount of time.
What to do next
- Compare savings accounts with Moneyfacts Savings Best Buys.
- Search for a savings account.
- Remember, always make sure you fully understand and are happy with the terms and conditions of the savings account before you part with your money. Happy saving!
