Spicing up your savings

The humble savings account has vastly improved over the last decade. It wasn’t that long ago that to get the best rates you had to agree to access your money at a few months’ notice.

Those days are long gone. Now you can get an easy access account which pays more than 0.5% above the Bank of England base rate. Rising interest rates have also boosted the returns for savers in the last few years, making this arguably the best environment for savers for quite some time.

That’s not to say that all savings accounts are worthy of your cash. Many accounts, particularly those available via branches and that are no longer actively marketed, offer derisory rates of interest. Indeed only about one in ten accounts pay more than the current base rate of 5.75%. Around half of accounts pay less than the rate of inflation, once you allow for tax.

Like many deals that are offered by banks, attractive rates are initially set on new savings accounts to lure in fresh money. Then, usually after a couple of years or so, you’ll find the rate being offered becomes steadily less competitive. A good example of this phenomenon is ING. It attracted billions of pounds of savers’ money when it launched in 2003. But by 2006, it started to lag the field and didn’t pass on rate rises. It currently offers just 5% AER, which is 1.3% lower than the best offers currently available from more recent newcomers such as ICICI.

Finding a good savings account

As is often the case, it’s helpful to start with what sort of accounts to avoid, in order to find the best account.

Many accounts offer initial bonus rates that last for around six months. Unless you’re willing to move your money around that frequently these accounts are best left on the shelf. The typical bonus ranges from 0.5% to 1.0%, meaning that a seemingly attractive rate can quickly become an also ran.

When you’re comparing accounts look at the AER, or Annual Equivalent Rate, rather than the gross rate. As the name implies, the AER will show you what rate of interest you’ll get over the first year you have the account, so it adjusts for any bonus rate and for any differences due to interest that is paid monthly rather than annually.

Some accounts also have a restriction that means you don’t get any interest in any month you make a withdrawal. If you plan to dip into your savings on any sort of regular basis these accounts are no good. If you make two withdrawals in a year for example, an account that pays out 6% will effectively be reduced to 5%.

Regular savings accounts at first sight offer exceptional value for money but come with too many restrictions for most serious savers. Most have a maximum monthly investment limit of £250. The eye-catching headline rate typically lasts for a year, after which time your money is transferred to an ordinary savings account which usually offers poor value for money.

One way of protecting yourself against your savings rate becoming uncompetitive is to look for an interest rate guarantee. ICICI’s HiSAVE savings account, currently paying 6.3% AER, offers to pay at least 0.25% more than the base rate until the end of 2007.

Boosting your returns further

There are various things you might be able to do to earn a little more interest from your savings. If you are not a taxpayer then you can opt to have your interest paid to you gross by filling out an R85 form, which your bank will provide you with. Unless you do this, your bank will automatically take 20% tax off your interest, so you’d have a claim a refund by filling out a tax return instead.

Cash ISAs are also worth investigating. You can put up to £3,000 each tax year into one of these accounts. Over 10m of us did so last year and will therefore benefit from tax-free interest as long as the money remains in the account. National Savings & Investment offer one of the best rates at the moment, paying out 6.3% and guaranteeing to pay at least 0.55% higher than the base rate until April 2008.

Next year, two things are happening which will help savers earn even more interest. In April, the annual limit for cash ISAs rises to £3,600, which is likely to make them even more popular. And by May, banks are promising to introduce a faster payment system which means any transfers you make will earn interest straight away rather than suffering the current three-day delay. So roll on next Spring!

If you can afford to put your money away for a year or more, then take a look at the current crop of fixed-rate savings accounts. The recent credit crunch has resulted in many banks offering highly attractive deals of almost 7%. It’s worth noting that if you’re worried that your money is at risk then, should the worst happen, you have protection from the Financial Services Compensation Scheme. This pays out 100% of the first £2,000 deposited and 90% of amounts between £2,000 and £35,000 in the unlikely event that a bank is unable to repay your deposit.

If you want to squeeze the very last drop of interest from your money, you can look at setting up an automatic sweep from your current account into a savings account. Alternatively you can open a high interest current account. While most current accounts still offer a paltry 0.1%, a new breed of accounts, including Alliance & Leicester’s Premier Direct account, have upped the ante considerably. It pays 6.5% AER until October 2008 on any balance below £2,500. It also offers a great overdraft rate, set at 0% for the first twelve months and 5.9% thereafter, which is useful if you occasionally stray into the red.