If you are saving up for something special – such as a holiday, a car or even a house, or you just have money to spare at the end of each month – it makes sense to find the best home for it, so it can work hard and make you the best return.
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Before you start to look for a savings account, you should take a good look at your finances in general. The first thing you should do, if you have any money to spare, is clear your debts. You are unlikely to be able to find a savings account that will beat the interest you pay on long-term debt, particularly as interest on most savings accounts is taxed. Therefore, the best thing you can do with any money left over at the end of the month is to put it towards your most expensive debt. That is probably your credit card balance, unless you are on a special 0% deal.
You could also consider putting surplus cash towards overpayments on your mortgage, or, if that is not permitted, setting money aside to make a capital repayment when the mortgage terms and conditions allow.
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Your next job when choosing a savings account is to decide how much access you need to your money. Are you saving for a long-term project, such as a dream holiday in a year or two, or are you trying to build up an emergency fund?
If you might need to dip into it at short notice, go for an instant access account, but if you can tie your money up for a while you may be able to get a higher rate by going for a fixed-term account or a notice account.
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If funds allow, you might actually opt for two accounts – one for long-term saving, building up a nest egg so that you don’t have to rely on borrowing for big purchases – and another for your rainy day money. While you want to get the best interest rate possible, there is no point tying yourself in to an inflexible savings scheme and being forced to borrow at a higher rate to do essential repairs or pay unexpected bills.
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Let’s make clear what “saving” actually means.
Saving is putting your money into a deposit account where it gathers interest. The amount you pay into your account won’t ever go down, and you will obtain interest on it, making it grow.
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While people do use the words interchangeably – perhaps talking about “investing in a building society” – saving is not actually the same as investing. Investing involves taking some degree of risk. When you withdraw the money you have invested, you might, if you are lucky, get a lot more money back than you would from a savings account. But you also run the risk of getting back less, and in the worst case you might not even get back what you put in.
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The reason that people are prepared to take a risk with their money is because they seek growth, and one of the reasons for this is the effect of inflation. The problem is that, if the interest rate you are receiving on your savings is not more than, or at least equal to, the rate of inflation, the buying power of your money will fall. So, if you pay £1,000 into your account today, in 10 years’ time that same £1,000 will buy, perhaps, only three quarters of the goods it would buy today. For example, if inflation runs at just 2.5% a year for the next 10 years, the purchasing power of £1,000 will have fallen to £776 compared with today. And remember that, because most of the interest you receive is liable to income tax, your money has to work even harder just to keep pace with inflation.
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However, many people do not want to take any risk with their money, particularly if they are saving for the short term. Savings are not subject to risk as investments are. The only risks you run are the effects of inflation (see above) and the remote risk of a default by the bank. You can, therefore, consider your savings to be “guaranteed” up to a certain point.
Banks and building societies operating in Britain are regulated by the Financial Services Authority, which makes them obey strict rules when looking after your money. Additionally, they are members of the Financial Services Compensation Scheme, which means that, in the extremely unlikely event of a default by a bank or building society, you would get your money back, up to a ceiling. Under the current rules, the maximum compensation for cash deposits is £35,000 per institution, made up of 100% of the first £35,000.
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To get the best rate on your cash, you need to understand how interest rates are stated and how to compare like with like. You will see three or maybe even four rates quoted for most savings accounts.
The gross rate is the rate of interest payable before deduction of income tax as required by law.
The net rate is the rate that you will receive in your account after income tax has been deducted (currently 20%). This is the rate that most people get unless they have registered to have interest paid without tax taken off (see children’s savings, below).
Curiously, the rate deducted is 20%, although the actual basic rate of tax in the UK is currently 22%. This is a Government concession to savers, and if you are a basic rate taxpayer, when you receive interest net of tax your obligation to pay is deemed to be satisfied and there is no more tax to pay.
Higher rate taxpayers who pay at the rate of 40% must pay a further 20% by declaring the interest they have received on their self-assessment forms, and then paying the amount due to the taxman after the end of the tax year.
Annual equivalent rate (AER) : is a notional rate which illustrates what the gross interest rate would be if interest was paid and added to the account annually. The AER helps you to compare rates that run over uneven periods or include a special bonus.
Monthly interest AER : If you elect to have your interest paid monthly instead of at the end of each year, the interest you actually receive will be less than the annual rate, because the interest will not be rolling up, earning “interest on interest”. The AER for monthly interest will help you to compare rates in these circumstances.
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Instant access
The simplest are bank and building society accounts operated with a cash machine card or a passbook. You can often open an account with as little as £1 and pay money in and take it out whenever you like. The price for convenience is that you will probably receive a non-competitive rate of interest, and this rate can fluctuate up and down depending on the Bank of England base rate and investment conditions.
Variants on instant access accounts are so-called Direct Access accounts. These can be operated over the phone or via the internet. You usually need to link the account to a bank account, and withdrawals are made by transfer into this account. While you can withdraw your money on demand, it may take a day or two for you to get your cash in your hand. Because of the savings in overheads that can be made by the banks in running these accounts via call centres rather than branches, you will get a better rate of interest with a direct access account than on a passbook account. Some direct access accounts will also let you withdraw your money from a cash machine with a card.
Among the top payers in internet accounts are Birmingham Midshires Internet Easy Access Account, and Icesave from the Icelandic Landsbanki, both paying 5.2%. ICICI Bank HiSave account pays 5.15%.
For those who prefer to save via a branch, the Co-operative Bank’s Smart Saver pays 4%. You can pay money into your account at any Post Office. You can also add money by post, in a branch, over the telephone, online or by standing order. You can withdraw money with a cash card.
Notice accounts
You can sometimes get a higher rate if you are prepared to give notice on your account. However, interest rates and marketing policies by the various savings institutions chop and change all the time, so don’t assume that giving notice will necessarily net you a significant boost in terms of interest. You are more likely to get a better return by switching from a branch to a telephone or internet account than putting your money in a notice account.
Chelsea building society’s Double Guarantee account pays 5.25% until 2nd May 2007. You are allowed penalty-free withdrawals subject to 80 days’ written notice. Immediate withdrawals are permitted, but will be subject to the loss of 80 days’ interest on the amount withdrawn. From 3rd May 2007 to 2nd May 2008 all withdrawals are penalty-free, subject to 40 days’ written notice, or the loss of 40 days’ interest on the amount withdrawn.
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Fixed rate
With these accounts, sometimes called “bonds”, you put your money on deposit for a fixed term, usually one or two years. The rate will be fixed at the outset and stays the same for the whole period, no matter what happens to the Bank of England base rate. The terms of the account will usually state that you may not make any withdrawals during the fixed-rate term, except in the case of the death of the holder. Some longer-term accounts will let you take your money out in an emergency or at a certain point in the term, although in that case you will probably have to pay a severe penalty.
West Bromwich building society’s E Bond 7 pays 5.65% for a minimum £1,000 deposit until 31/10/2007. No withdrawals are permitted.
Cheltenham & Gloucester has a one-year fixed-term bond paying 5.5% until 31/10/2007. An emergency withdrawal facility is available, subject to a 120-day interest penalty on the amount withdrawn. Withdrawals are by cheque and only by post through C&G Invest Direct. The minimum investment is £500.
Tracker
Tracker bonds work in a similar way to fixed-rate bonds, but the interest rate will be pegged to an external indicator – usually the Bank of England base rate. A tracker bond will typically have an interest rate set at a certain number of percentage points over base rate and then mimic base rate movements from thereon. So, if base rate rises – or indeed falls – by 0.25% during the term of the bond, the interest rate on the bond goes up – or drops – by the same amount.
Dudley building society has a one-year tracker bond with interest linked to the Bank of England Base Rate, currently 4.75%, on deposits of £5,000, rising to 5% on deposits of £50,000.
Regular saver
If you can afford to put by a little each month on a regular basis, a regular savings account is well worth having. There are some astonishingly good rates of up to 12% available for regular savers, often linked to the individual banks’ own current accounts. But beware: on some accounts with higher rates you are often not able to withdraw from the account for a year, and with those that do let you make withdrawals you will pay a hefty penalty.
For instance, Alliance & Leicester’s regular saver, paying 12% with a minimum investment of £10 and maximum monthly investment of £250, permits no withdrawals. Deposits cannot be made by cash or cheque – you have to transfer money from an A&L Premier Regular Saver account.
Barclays has a similar account, paying 10% linked to its current account.
For a “free-standing account”, not linked to a current account, Ipswich building society’s Target Saver is paying 8.25% on £90 per month minimum. Partial withdrawals are not permitted. The account can be closed without notice, but a 120-day interest penalty will be applied.
Bonus savers
Some regular saving accounts are designed around a bonus system (see Bonus accounts below). They pay a low basic rate, but you are paid a bonus if you make fewer than a certain number of withdrawals a year. You are getting the best of both worlds here, if you think there is a chance you might need to get access to your cash. The rules allow withdrawals, but if you are lucky enough not to need to get your money back during the term of the account, you will get a bonus at the end of it.
Ipswich building society’s Olympic account pays 7%, including a bonus of 2.35%, and you need to make 11 monthly payments to get the bonus. The minimum monthly payment is £10, and the maximum is £50.
Monmouthshire building society’s Saver Plus account pays 5.55%, including a 3% bonus, for a minimum of £20 a month. One penalty-free withdrawal per year can be made without affecting your bonus. Up to three withdrawals are allowed during a year, and more than three withdrawals will result in closure of the account.
Other bonus accounts
Bonuses work well with regular savings accounts (see above), but do take care out with headline-grabbing special offers on other accounts. Often you will see accounts topping best-buy tables with a little asterisk next to the rate, saying something like “includes 0.5% bonus for the first six months”. If you are planning to save over this period, that’s fine – or if you think you will remember to move your money when the bonus period is up. However, the banks and building societies rely on your inertia to leave the account in situ. So, if you think you might not get round to taking action when the time comes, look for an account with a good overall rate and not necessarily one that’s reaching for the stars.
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Don’t forget that everyone over the age of 16 can put money into a mini cash ISA (individual savings account).
ISAs allow you to get the interest from your savings free of tax, which means they grow faster. Also, the banks and building societies tend to pay a better rate of interest on their ISAs than on other savings accounts, so it often pays to choose an ISA even if you are not a taxpayer.
Remember, you can only open one cash ISA in any one tax year. If the rate you are getting becomes uncompetitive you can, however, transfer to another provider.
If you are saving in a cash ISA there are some rules to remember:
- You can put in a maximum of £3,000 in any one tax year. You can withdraw your money, but you cannot top up your holding if topping up would mean that you had paid in more than £3,000 within the year.
- For instance, if you opened your account with a £2,000 deposit and then withdrew £1,000, you would be allowed to pay in only a further 1,000 (making a total of £3,000 paid in over the year).
- This means that, if you have other sources of cash for emergency spending, it might be better to use them first; otherwise you could lose valuable tax relief. The ISA allowance has to be used each tax year to take advantage of it – it cannot be backdated or carried forward from year to year.
- If you decide to move your account to another provider, make sure you arrange a transfer. On no account simply withdraw the money or you will lose your allowance for that year, and possibly breach the rules for the current year if you have already opened an account this year.
IMPORTANT:
If you open a cash ISA – with up to £3,000 – you may also open a mini stocks and shares ISA, with up to £4,000 in the same tax year. You may NOT, however, also open a maxi stocks and shares ISA (with up to £7,000) in the same tax year if you have a cash ISA. So, before going ahead with your cash ISA, consider how much you might want to invest in a stocks and shares ISA, if that is what you want to do, because, once you have opened your cash ISA, your option for stocks and shares will be limited.
There are plenty of good cash ISA deals to be found. National Savings & Investments’ Direct ISA pays 5.3%. Unlimited withdrawals can be made online or by phone. The minimum withdrawal is £250, which will be paid into a nominated bank account.
Kent Reliance building society pays 5.21% on its direct variable-rate mini cash ISA. Withdrawals can be made whenever required without notice or penalty. All withdrawal and deposit requests should be sent to the Society’s head office.
Yorkshire building society e-ISA pays 5.15%, and Teachers building society pays 5.05% on its mini cash ISA, which is available by post for a minimum deposit of £1,000.
TESSA Only ISAs (Toisas)
These were accounts made available to holders of maturing Tessas (Tax Exempt Special Savings Accounts), the predecessor of Isas. You can no longer open a Toisa, but if you opened one when they were available they are now treated in the same way as ordinary Isas for the purposes of withdrawals and transfers. Check with your own provider if it imposes any special rules for the account you have.
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Children
Banks and building societies often offer accounts at advantageous rates to young people, to encourage saving. Some give away free gifts, such as money boxes or stickers but, as with all accounts, look at the interest rate when you make your choice. Watching their money grow is a valuable way for the child to learn how interest works.
Many building societies won’t let the over-16s have children’s accounts, but one or two will let young people continue to save. These accounts can be particularly useful for students and young people saving to go to college.
Children and young people are liable to pay tax in the same way that adults are. However, in most cases their income will be well below the tax-free allowance that everyone has before they pay income tax. If the only income that your child has is the interest from a savings account, he or she should be able to register to have the income paid tax-free. Ask the bank or building society for form R85 to get this done.
Note that, if the child’s money has been given by a parent, and if the interest in all the child’s accounts (if there is more than one account in the child’s name) totals more than £100 in any one tax year, the interest is taxable as if it were the parent’s income, at the parent’s highest marginal rate. This rule applies only if the money in the child’s account has been given by a parent and does not apply to gifts from friends, grandparents or other relatives.
Halifax Children’s Regular Saver pays 10% for the under-16s. No withdrawals are permitted until the capital and interest have been swept into another Halifax account at the end of each account year. Withdrawals are then subject to the conditions of the account the money has been swept into.
Bradford & Bingley’s Smart Save pays 5.25% for 13-25 year olds. This instant access account, which has no penalties for withdrawal, follows on from the bank’s First Save account for the under-13s.
Harpenden building society’s 18 Club pays 5.22%. Withdrawals, including closure, cannot be made until the 18th birthday. The society also has a 21-Club account, paying 5%, for the over-18s whose 18 Club account has matured or new investors aged 18 to 21. Three withdrawals are permitted each year without notice or loss of interest.
Saffron building society’s branch and postal Ladybird account is open to those aged up to 16, with no withdrawal restrictions.
Norwich & Peterborough building society’s branch-based HeadStart II is available for the under-24s and pays 4.70%.
Coventry building society has a new cashcard account called Intro for young people aged between 11 and 17. It pays 4.6%. Applications can be made in person at branches or over the telephone. Statements can be viewed online.
Child Trust Fund
All children born after September 2002 receive a £250 voucher to be put into a special account which they can access when they are 18. They receive a further £250 when they are seven years old. Parents and friends can add to the account up to a maximum of £1,200 per year. The fund grows free of income tax. The Government is keen for parents to invest their CTF money in a stocks and shares account because of the greater opportunity for the money to grow, and there are a variety of accounts available from banks and building societies and independent providers.
However, many parents prefer to keep their savings in cash, and CTF cash savings accounts are available from most banks and building societies. Some building societies, which deal principally in cash accounts, have teamed up with other companies to provide a stocks and shares product as well as their own cash account.
If you want to stick with cash, the following accounts are among the best payers:
Yorkshire building society is paying 5.55% on its Child Trust Fund cash account; Chorley & District building society and Hanley Economic building society are both paying 5.5%, Skipton building society is paying 5.3%.
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At the other end of the spectrum, many savings institutions are offering special accounts to older savers.
These fall into three groups: bonds, similar to those on offer to other age groups, but often with a slightly higher rate or available with monthly interest; those that offer a passbook-based account – the sort that is often favoured by the elderly – with a higher rate of interest than other passbook accounts offered by the bank or building society; and deposit accounts operated via a branch, by telephone or over the internet; often requiring the saver to deposit their pension into the account.
Among the first category, Saga has a range of bonds for older savers paying up to 5.6%. Similarly, Newcastle building society’s Newcastle 50+ (Issue 2) is a fixed-interest account paying 5.35% fixed until 16th November 2007. Withdrawals are permitted subject to the loss of 30 days’ interest during the fixed term. After the fixed term withdrawals can be made penalty-free.
Among the branch-based accounts, West Bromwich building society’s instant access Oak account is currently paying 4.25%, to people over 60 who have their pension paid into the account. The minimum account balance is just £10.
Leeds building society’s Flexible Freedom passbook account for the over-50s is currently paying 4 .7%, and is guaranteed to match base rate less one percentage point until 1 September 2010.
Skipton building society’s branch-based Pension Plus pays 4.6%. You must be 50 or over and pay one or more pension credits into your account on a regular basis. Other investments can be added to the account at any time. The minimum opening investment is £500 and the maximum you can have in the account is £25,000.
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Banks and particularly building societies often offer preferential rates to people with existing accounts, or put savers on to a better rate once they have held their accounts for a certain amount of time.
These accounts tend to come and go, and the so-called loyalty bonds are usually on offer for a short period, so have to be snapped up quickly.
Nationwide is currently offering a Members’ ISA bond at 4.95%, 0.3% above its normal ISA rate of 4.65%, for savers who have been with the society for three years or more.
It also has a Loyalty Tracker Bond, which tracks the Bank of England Base Rate. So, if Base Rate changes by 0.25%, the annual rate will change by the same amount. The current rate is 4.55%.
Portman building society’s Members’ Loyalty Account (Issue 2) is paying 5.25% to savers who have been members for three years or more, have had an average balance of £2,500 over the last year or have a current mortgage with the society. The interest rate is guaranteed to be 0.50% above the Bank of England Base Rate for one year, and the rate will then equal the Bank of England Base Rate for a further two years. The minimum investment is £500, and 90 days’ notice of withdrawal must be given or there is a 90-day interest penalty.
Coventry building society has a CallSave Privilege ISA for savers who have been members of the Coventry for five or more years. It pays 4.75%, compared with 4.3% on the society’s ordinary Square Deal ISA.