How to get the best savings account, whatever your needs.
Savings accounts are more complicated than you think. For example, it would be reasonable to assume that a bonus is a good thing, and an easy access savings account means your savings are easily accessible.
But this is not always the case. And if you make these assumptions and pick the wrong account, it could cost you dearly.
Today, I'll run through all you need to know.
AER
The AER (Annual Equivalent Rate) is designed to make comparison easy and it works. Regardless of when you open your account, and whether the bank pays interest monthly or annually, the AER will tell you how much you'll earn. If it's 4% AER, you'll earn 4% interest on your savings over the next 12 months - as long as the rate stays the same.
However, there's no guarantee that it will - so always check whether the AER is fixed or variable.
Bonuses
Say you had to choose between two accounts paying 3% AER. No difference in the rate, except that the rate on one account includes a fixed 1% bonus for a year.
Which one should you go for? In the past, we'd have said the one without the bonus. Having a bonus is not as good as it sounds; it simply means the interest rate will plummet after a year.
However, recently, as we've had super-low interest rates, bonuses have acted more like short-term guarantees. After all, if you have a 1% fixed bonus, your interest rate can't fall below 1%, while the bonus is in place.
The key thing is to avoid is a variable rate bonus. This is utterly meaningless, as effectively the bonus rate could completely disappear, so you don't have a guarantee of anything.
Quick access to your money
If you want to keep your savings flexible, get an easy-access account. These accounts are suitable for the majority of people and the best ones have, in the past few years, usually beaten inflation after tax. This means that these accounts protect your savings from rising prices.
Every month or two, it's best to look at the interest rate you're earning (which can change) versus the best rates on the market, to ensure you always get the best rate.
Features you want to see:
- The highest AER. Currently the top accounts are paying at least 3% AER.
- Good access to your money, whether your preferred method is the Internet, the post, telephone or branch.
- Fixed interest. This type of savings account usually has a variable rate, but once in a while you can get one with a good fixed rate. Easy access and fixed interest is a good combination.
- You can also get easy-access ISAs, which allow you to save tax-free. You can save up to £3,600 per year in these. (£5,100 if you're 50+ by 5 April 2010.)
Negative features to watch out for:
- Some accounts call themselves easy-access, but there are penalties for making withdrawals or restrictions on the numbers of withdrawals you can make. Normally, you don't get paid higher interest to make up for these worse terms. So, avoid accounts that penalise you for making withdrawals.
Getting in the savings habit
A good account for getting in the savings habit is a regular saver, because you're obliged to set up an automatic monthly payment. You can usually choose the size of the payment from £10 to £250. Unlike easy-access accounts, you typically get a fixed interest rate, perhaps for one year, but there are penalties for making withdrawals and sometimes withdrawals aren't allowed before the agreed period is up.
Features you want to see:
- As usual, you're looking for a high AER. Today, this means you want to earn more than 4% AER.
- A fixed interest rate.
- Occasionally you'll find unusually flexible regular savings account, such as this one from Barclays, paying 4.25% AER. With regular savers like this one, you can change your monthly payments, and there's just a small penalty for making withdrawals. Read more here.
Negative features to watch out for:
At the end of a year, your savings are usually shifted to a lousy savings account. If you leave your money in this account you will quickly undo the good work you did, so you must shop around. It's a constant battle to beat inflation!
Three more types of account
To save repeating myself, I can run through the next three types of account more quickly:
Notice accounts
With a notice account, you must give notice before you make a withdrawal, typically 90 days. In the past few years, these accounts have normally paid little more interest than an easy-access account, so they're not normally worth it. Stay away!
Term accounts
Term accounts (or bonds) typically pay fixed interest and last for an agreed period, like regular savings accounts. However, you pay into them just once and you get hefty penalties for withdrawals. Your money is tied in for one to five years. The longer you're willing to tie up your money, the higher the interest you'll earn. However, the risk is also higher that you'll be stuck on a fixed interest rate whilst more flexible accounts rocket passed. At present, I wouldn't fix for more than a year, as I explained here.
NS&I's index-linked savings certificates
These sound complicated, but they're not. Basically, they're guaranteed to pay you tax-free interest that's a little over inflation, ensuring your money grows with prices regardless of how rapidly this happens. Your entire pot is guaranteed by the Government - so it's 100% safe.
The downsides are that you can just invest a lump sum, your money is tied in for a year or you lose all the interest earned, and the interest rate you earn rarely comes close to the best savings accounts in any of the other categories I've mentioned, even after tax.
Get help from lovemoney.com
If you need a bit of help getting into the savings habit, we can help.
First, adopt this goal: Build up an emergency savings pot
Next, watch this video: How to save when you've got no money
And finally, why not have a wander over to Q&A and ask other lovemoney.com members for hints and tips about what worked best for them?
Earn up to 4.25% AER with a savings account from lovemoney.com
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