Save on a regular basis
Even a modest amount of interest can make a big difference. For example, deposits of £200 a month into a cash individual savings account paying 3% will have grown to £7,540 at the end of three years. Of this, £340 will be pure interest.
Although the financial incentives are there, it does take discipline to direct some of your hard-earned cash into a savings account.
Michelle Slade, spokesperson for financial data website Moneyfacts, says there are ways to make this easier. She recommends setting up a direct debit that takes the money out of your current account on payday.
"This helps to reduce the temptation to spend it," she says. "You can also make it easier to save by going for a notice account or a fixed-rate deal, both of which make it harder to access your cash."
Because of its tax status, a cash ISA should be your first port of call. You can save up to £5,100 in one in the 2010/11 tax year, equivalent to £425 a month.
"If you pay tax, or might pay tax in the future, go for a cash ISA before other savings accounts. Interest is paid gross so your savings grow faster," says Slade.
For example, as of 25 May 2010, Barclays Golden ISA was popular, paying 3.06%. To get a taxed account paying the same amount of interest, a basic-rate taxpayer would need to find an interest rate of 3.83% and a higher rate taxpayer, 5.10%.
Once you've used up your ISA allowance, it's worth looking at standard savings accounts. As well as deciding whether you'd rather have easy access or tie your money up, you might also want to consider a regular savings account.
"You will be tying your money up with these, usually for around a year, and there can be caps on the amount you save, but the rates are often attractive," adds Slade.
For example Northern Rock's Fixed Rate Regular Saver pays 5% as long as you commit to regular savings until June 2011. The maximum you can save is £250 a month.
Whether you're looking for an ISA or a standard savings account, Slade also recommends checking with your current account provider.
"There can be some good deals around if you already bank with the provider, although it's usually not worth switching current accounts to get a better deal on your savings," she explains.
Fixed rates versus easy access
Deciding whether to tie your money up with a fixed-rate savings account or go for one that offers easy access will be determined by a number of factors. Ask yourself the following questions:
What's the rate?
Having the highest possible rate will enable your savings to grow faster. According to Moneyfacts, although the best instant access account, offered by Manchester Building Society, pays 2.66%, you'd get 3.25% on the United National one-year fixed deposit or 5.00% if you're happy to tie your money up for five years with the Coventry Building Society, State Bank of India or ICICI Bank UK (rates correct when going to press).
What are you saving for?
Think about your saving goals. If you're saving for a fortnight in the sun this summer, easy access is probably your best bet, allowing you to pay for flights and so on. If it's for a house deposit in a few years, tie it up and earn the extra interest.
How disciplined are you?
If your good savings intentions never last until next payday, plumping for an account that ties up your money will help develop your financial discipline.
A savings account on which the account holder is required to give a period of notice before making a withdrawal or face a penalty, usually a loss of a specific number of days’ interest or pay a fee. Notice periods of 30, 60 or 90 days are common. These accounts usually pay higher than average interest rates and require large initial deposits (£1,000 minimum) so the notice period and penalties are there to discourage withdrawals. Some of these accounts will only allow a certain number of withdrawals a year.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.