Your top 10 savings questions answered
Savings rates have gone from bad to worse in recent months as banks, building societies and supermarkets pull the plug on their top-paying saving accounts.
So what can you do to get the most out of your cash? And what mistakes can't you afford to make in this low-interest environment? Here we answer your top savings questions.
1. THE TOP RATE I FOUND INCLUDES A BONUS. IS THAT A BAD THING?
If you want a half-decent return on instant-access savings, you'll probably have to opt for an account that pays a temporary bonus. These typically last for around 12 months, but they are controversial because when they expire the rate suddenly drops.
However, provided you make a note of when this will happen to remind yourself to check your rate and that you're prepared to switch accounts, this need not be a problem. You will normally have to put up with a lower rate at the start if you want to avoid the hassle of regular switching.
2. CAN I GET A BETTER RATE FROM MY OWN BANK?
Banks have caught on to the concept of rewarding faithful customers, so it's worth checking out offers from your own bank. In the past, they've seemed more interested in snaring new customers with top rates, but many are now focusing on the loyalty of their current account holders too.
3. SHOULD I GO FOR A FIXED DEAL?
It depends on your individual circumstances. If you're happy to lock your money away for a set period you could benefit from higher interest rates.
The longer you save in a fixed-rate bond, the higher the rate of return you can get - but the greater the risk of being locked into that rate when interest rates do start to rise.
4. ARE THERE ANY ALTERNATIVES TO TRADITIONAL SAVINGS ACCOUNTS IF I DON'T WANT TO INVEST?
One option is one of the UK's 500 credit unions offering savings accounts and lending facilities. Traditionally they have catered for those excluded by the banks, but they are becoming more popular. These are not-for-profit institutions owned and controlled by their members, so when you become a customer you become a member.
For example, the Clockwise Credit Union (clockwise.coop) offers members a basic share account and a less easily accessible budget account. Interest is paid in the form of an annual dividend (the union's cash surplus) divided between members.
Another alternative is a social lending site such as Zopa, YES-secure or Funding Circle. They match people with money to spare with those who want a loan. As they cut out the middleman, borrowers are able to secure a loan at a competitive rate, while lenders get a decent return on their cash.
But although the returns far outweigh those paid by the banks, a concern is that customers are not protected under the Financial Services Compensation Scheme (FSCS).
However, the various peer-to-peer lenders have taken steps to safeguard their customers' money, and the average default rate on loans is less than 1.5%.
5. WHY DO BANKS LAUNCH RATES AND THEN WITHDRAW THEM A DAY LATER?
Market-leading deals are oversubscribed very quickly. For example, in September 2012 Sainsbury's market-leading five-year bond at 4% was withdrawn just a day after launch, due to demand. "Customers piled in to take up the deal," says Rachel Springall from moneyfacts.co.uk.
"Top rates get a barrage of attention, so savers who want to take up these deals need to act quickly to ensure they are not disappointed."
6. I CAN ONLY SAVE £20 A MONTH. SHOULD I EVEN BOTHER?
If you're trying to save, putting away a little on a regular basis is a good start, says Jason Witcombe, director of IFA Evolve Financial Planning. "The key to saving is to get started and stick with it; every long journey starts with one small step."
There are plenty of regular saver accounts on the market that allow small deposits so long as you save each month for a year. "For example, you could build up a good safety net of £240 after 12 months and earn 3.3% in interest with West Brom BS' Fixed-Rate Regular Saver," adds Springall.
7. CAN I USE AN OFFSET MORTGAGE TO SAVE?
Given low savings rates, it may make more sense to use your savings to cut your mortgage repayments by taking out an offset mortgage. This works by ‘offsetting' your savings against the total debt of your mortgage, so rather than earning interest on your savings, you pay less on your mortgage debt.
For example, if you have savings of £15,000 and an outstanding mortgage of £100,000, you will only pay interest on £85,000. Another benefit – particularly for higher-rate taxpayers – is that because you are not earning interest on your savings, you won't pay tax on it.
However, this tactic is only really worthwhile if you have substantial savings that will make a big dent in the amount of mortgage on which you pay interest.
8. WHY DO PEOPLE WITH THE SAME SAVINGS ACCOUNTS EARN DIFFERENT RATES?
Banks and building societies often change the interest rates available on accounts without changing the account name, so it is possible for the exact same account to pay different interest rates to different people.
This happens because the providers may push up their rates on a short-term basis to attract new customers, leaving existing customers on lower-paying rates; but it can be hard to spot.
9. WHAT'S BEST: ANNUAL OR MONTHLY INTEREST?
Some savings accounts will offer you the choice of monthly or annual interest. If you are saving for the long term, annual interest would suit you. However, if you are using interest on your account to top-up your income or pension then monthly would be the best option.
Theoretically, the effects of compound interest would mean you earn a higher return with monthly interest but most banks would pay a slightly lower monthly gross rate to compensate for this. So even if the advertised gross rates were different, the annual equivalent rate (AER) would be the same whether you plump for monthly or annual interest.
10. HOW CAN I PAY LESS TAX ON MY SAVINGS?
First, make sure you maximise your cash ISA allowance every year (£5,760 for 2013/2014) by shopping around for the best ISA rates on comparison sites such as moneysupermarket.com or indeed moneywise.co.uk.
Additionally, if your partner pays a lower rate of tax than you, you could transfer assets into their name. That's because in an ordinary savings account, basic-rate taxpayers will pay 20% tax on their savings interest but higher-rate taxpayers will pay 40%. This makes particular sense if one of you is a non-taxpayer, as you are entitled to receive savings interest tax-free.
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.
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.
The name given to a certain type of financial transaction which takes place directly between individuals or “peers” without the use of a traditional financial institution such as a bank. Various social lending websites incorporate a number of strong risk controls, and screen all potential borrowers by checking their credit history. Lenders agree to lend a specific amount for a stated return and lenders’ cash is pooled between borrowers, spreading the risk. The major social lending companies are Zopa, RateSetter, Funding Circle, Quakle and Yes-Secure.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
A way of combining a mortgage and savings so the savings “offset” and reduce the mortgage. Rather than earning interest on savings, the savings reduce the mortgage and the interest paid on the borrowing, so savings are effectively earning interest at a higher rate than most mainstream savings accounts will pay. They are also tax-efficient, as savers avoid paying tax on interest that their deposits would otherwise have earned. Offset mortgages offer the disciplined borrower a great deal of flexibility, as overpayments can be made to reduce the term or monthly mortgage repayments, which can save thousands of pounds in interest payments over the mortgage term.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
This is effectively paying interest on interest. Interest is calculated not only on the initial sum borrowed (principal) or saved (see APR and AER) but also on the accumulated interest. The more frequently interest is added to the principal, the faster the principal grows and the higher the compound interest will be. Compound interest differs from “simple interest” in that simple interest is calculated solely as a percentage of the principal sum.
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.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Where APR is the rate charged for money borrowed, Annual equivalent rate is how interest is calculated on money saved. The AER takes into account the frequency the product pays interest and how that interest compounds. So, if two savings products pay the same rate of interest but one pays interest more frequently, that account compounds the interest more frequently and will have a higher AER.