Supersize Your Savings – Act Now!

It should be relatively easy to get a decent interest rate on your savings you’d think. Open an account with your local bank and they should pay you the going rate. If only things were so simple. Banks reserve their best rates for new customers and loyal customers are often left with accounts that actually lose them money once inflation is taken into account.

How rates vary

When a bank launches a new savings account is normally has a very attractive rate of interest. Sometimes it’s so attractive that they get deluged with applications and it can take weeks to open an account! This honeymoon period normally lasts for a year or two. Then the interest rate starts to fall back and the account gradually drifts lower and lower down the Best Buy tables.

At the time of writing for example about 15% of easy access accounts offered an interest rate of 1% or more than the Bank of England’s base rate. And a total of 40% offered interest equal or greater than the base rate.

So this means over half of accounts actually paid less than the base rate. Indeed a quarter of them actually paid 1% less than the base rate or even lower. When you consider that these are just accounts open to new customers, it’s apparent that the true proportion of accounts paying a dismal rate of interest is startlingly high.

To be fair, banks do make some effort to keep their customers informed about poor rates. As well as receiving notifications about changes in interest rates, under the Banking Code, you should receive a list showing the interest rate of all the accounts offered by your bank at least once a year provided your balance is £500 or more. You should also be notified if your account’s interest rate falls “significantly” against the base rate and you have £250 or more in your account.

Finding an account

When you compare interest rates always look at the Annual Equivalent Rate or AER. This is the average rate of interest you’ll receive over the course of the first year of the account. It smoothes out any differences between accounts that pay interest on a monthly or annual basis. It also helps you adjust for any short-term bonus rate that an account may offer. Many accounts pay a bonus rate for the first six months, helping them appear higher up the Best Buy tables. Once the bonus is gone, the rate paid is usually far from competitive.

One thing to keep an eye out for is interest rate guarantees. As we mentioned earlier, most accounts drift back to mediocrity after a while, but some offer a guarantee that they will pay a certain amount above the base rate for the next few years. If you’re looking at two accounts paying the same rate, then an interest rate guarantee can be the deciding factor.

What else to look for

The interest rate you receive is obviously by far the most important thing to look at when choosing an account. Watch out for tiered rates, where the rate paid rises depending on how much money you have in the account. For the most part, such accounts are rarely the best payers.

Many accounts will let you start with a little as £1 but some require an opening balance of £1,000 or even higher. Also look to see how you can access your account. Branch, telephone, post and online are the main methods but it’s quite rare to get a top-paying account that offers all four different options.

Easy access accounts are often but not always the highest payers. Sometimes notice accounts or fixed-rate accounts can offer better value although check to see what penalties apply should you need to get your money urgently. One option, if you’re flush with cash, is to keep some of your savings on easy access and the rest on higher-paying notice or fixed-rate accounts.

Paying less tax

The tax man takes a sizable chunk of our savings interest. Banks automatically pay interest after deducting the basic rate of tax of 20%. But if you’re a non-taxpayer you can fill out an R85 form in order to receive your interest gross. If you’ve paid tax on your interest in prior years when you didn’t need to you should also be able to reclaim it if you contact your local tax office.

If you trust your partner and they pay a lower rate of tax than you, then transferring savings into their name can save you tax. And don’t forget that everyone aged 16 and over has an annual allowance of £3,600 each year that they can put into a cash ISA and earn their interest tax-free.
It’s also worth investigating some of the tax-free products offered by National Savings & Investments. Index-linked certificates often offer good value, especially for higher rate taxpayers, as they pay a rate linked to and often above the Retail Price Index over terms of either 3 or 5 years.

Keeping your money safe

The events on Northern Rock have focused everyone’s attention on how safe their money is when it’s deposited at a bank. In the UK we have the Financial Services Compensation Scheme which is designed to pay out when any regulated firm hits the buffers. The current compensation limit for savings is 100% of the first £35,000 deposited per authorised institution per person although the government is proposing to change this to £50,000 per person per bank by the end of 2008.

It seems very, very unlikely that any UK bank would be allowed to go bust but if it’s a concern you have then putting no more than £35,000 into any single account is the way to go. Remember that if you have a joint account you should be protected up to £70,000. If you have more than £35,000 but spread over different companies owned by the same bank, with no more than £35,000 in each single account, you may also be fully protected as long as each company is separately licensed. Ask your bank if you’re any doubt.

Foreign banks operating in the UK are also covered by this scheme. However some are also covered by their own domestic compensation schemes as well. In these cases, any compensation you receive would come first from the foreign scheme and then be topped up to £35,000 if necessary by the FSCS. Let’s hope things never get this far though!