Introduction to Saving
| Interest Rates - Figures to the end of December 2011 |
| Type |
Chart |
Annual Rate |
Difference on Year |
| Bank of England Base Rate (current rate) |
 |
0.50% |
 0.00% |
| Easy Access Savings Account (Average) |
|
0.30% |
0.07% |
| Cash ISA (Average) |
|
0.50% |
 -0.10% |
| Premium Bond Prize Rate (current rate) |
|
1.50% |
0.00% |
| Source: Bank of England / NS&I. |
What is it?
Saving means tucking away spare cash somewhere safe so you can use it in future.
If you spend less than you earn, chances are you'll have some money to save. Saving is important as, short of a fortunate windfall, it's the only way most of us
can accumulate a financial umbrella to cope with 'rainy days' (e.g. building/car repairs, unemployment etc.).
Saving money could mean anything from hiding it under your mattress to depositing it in a bank, but the key is that the cash is safe and that
you can get your hands on it when needed. Yes, it is possible to 'invest' the money instead with the prospect of sexier returns; but you could lose out, especially
if your 'rainy day' coincides with the investment plunging in value!
Interest
While storing cash in a jar or under a mattress might appeal to some, it's not a very good idea. The money won't grow unless you add more to it.
Much better to 'earn' some extra money, called 'Interest', in exchange for letting someone else use your cash while you don't need it (on the promise they'll return
it to you when needed). Of course, you'd probably feel uncomfortable doing so with any old Tom, Dick or Harry, which is where banks and building societies come in.
If you put £100 under your mattress you would still have
£100 25 years later.
If you had instead put the cash in a savings account with annual interest of
3% it would have grown to around
£209 over the same period.
When you deposit money in a savings account with a bank or building society they can use this to lend to someone else, perhaps via a loan or mortgage. They profit by lending out
your money out at a higher interest rate than the one they're paying you (the difference is known as the 'interest margin').
Interest, which is usually paid either monthly or annually, is quoted as an annual percentage rate before any tax is deducted (i.e. 'gross'). For example, an interest rate of 3% gross per annum (p.a.) means you'll
receive £3 each year for every £100 held in your account.
Accounts that pay interest monthly usually pay a slightly lower rate of interest than a comparable account paying annual interest. This is due to compounding. However, fear not, banks and building societies
must show both the actual interest rate and the Annual Equivalent Rate (AER), which factors in compounding.
The concept of compounding is really simple - you earn interest on the interest you've already received. For example, if you save £100 earning 3%
(i.e. £3) interest in year 1, you'll benefit from
interest on £103 in year 2 (i.e. £3.09 at 3%). Over time,
compounding can make a very worthwhile difference to the return you enjoy on your savings.
So, if an account pays interest monthly at 3% p.a., how much is this really worth?
The interest paid each month will be 1/12 of 3%, i.e. 0.25%. If we start with £100 it will
be worth £100.25 at the end of month 1 (£100 + 0.25%), £100.25 +
0.25% at the end of month 2 and so on. At the end of month 12 it would be worth £103.04, equal to a
total annual return, or AER, of 3.04%.
Use the Candid AER Calculator to check your own compounding examples.
Don't ignore debts!
Because banks and building societies profit by lending out your money at a higher interest rate than the one they're paying you, it's rare to earn a higher rate of
interest on your savings than you'll be paying on your debts.
A basic rate taxpayer putting £1,000 in a savings account paying
3% gross p.a. for 3 years would earn around
£74 of interest after tax.
If they also had a £1,000 debt on a credit card at an annual interest rate of
18%, they would have paid nearly
£643 of interest after 3 years
(ignoring minimum monthly payments).
Saving at the expense of paying off the credit card could cost this individual around
£569!
Therefore, if you have debts, it normally makes more sense to pay them off before you start saving. The only exceptions are if you have free/very low cost
debts (such as 0% credit cards or a student loan) or the penalty for paying off the debt early is prohibitive.
Tax
The taxman gets everywhere and your savings are no exception.
Non TaxpayerStarting RateBasic RateHigher RateTop Rate
If you're a non-taxpayer then there's no tax to pay on your savings interest provided it doesn't tip your income above your personal income tax allowance.
Make sure you give a completed HM Revenue & Customs (HMRC) form
R85 to your bank or building society. This ensures you receive interest without tax being deducted, i.e. gross.
If you're on the 10% starting rate of tax you can claim back the difference between the basic and starting rates of tax, i.e. 10%,
via HM Revenue & Customs (HMRC) form R40.
Savings interest is normally paid after basic rate tax (currently 20%) has been deducted. You'll have no further tax to pay
provided the interest doesn't push your income into the higher rate tax band.
Higher rate taxpayers must pay higher rate tax (currently 40%) on their savings interest less any basic rate tax already deducted
by the bank or building society. The additional tax is paid via your annual tax return or PAYE.
Top rate taxpayers currently pay tax at a rate of 50% on their savings interest less any basic rate tax already deducted
by the bank or building society. The additional tax is paid via your annual tax return or PAYE.
Use the Candid Savings Tax Calculator to see how tax affects your savings income.
It's a fallacy that UK taxpayers don't have to pay tax on interest from offshore savings accounts. HMRC requires interest to be
declared and tax paid via
annual tax returns.
Some savings products, notably Cash ISAs and NS&I Certificates are tax-free, hence well worth a look for
taxpayers.
Couples with savings should plan carefully if one partner is in a higher tax band than the other. The example below shows the financial benefit of holding savings in the
name of the partner in the lower tax band.
| Figures show interest, after tax, based on gross annual interest of £1,000 |
| |
Mr Rich
(higher rate taxpayer) |
Mrs Rich
(non-taxpayer) |
Joint Account |
| Net Interest |
£600 |
£1,000 |
£800 |
Of course, moving savings between partners does involve an element of trust...but it can be a simple way of saving tax.
Use the
Candid Couple's Savings Tax Calculator to discover whether moving savings between you and your partner could save tax.
Inflation
As a saver, inflation is your enemy. Rising prices of goods and services mean that your money will be worth less in future than today, so your savings could fall
behind.
For example, if your savings account pays 3% after tax and inflation over the year is 3%
then you're no better off. Worse still, there's a chance that over time the interest you receive on your savings is lower than inflation, especially if you're a taxpayer.
This means you might actually be worse off in future!
We're currently in an unusual environment where inflation has, at times, been negative. This means your money would be worth more in future than today. Given
this has been accompanied by a period of very low interest rates, there's sadly little reason for savers to rejoice. Also, because the biggest contributor to negative
inflation (Retail price Index) has generally been lower mortgage interest rates, there's less impact on savers who've already paid off their mortgage.
Over the year to
December 2011, the Retail Price Index
rose by
4.8%.
At this rate, the cost of goods and services will
double over
14 years and
9 months
NS&I Index-Linked Certificates offer a way for savers to combat inflation, as they pay interest over and above the Retail Price Index (RPI).
Returns are also tax-free.
Use the Candid Money Savings vs Inflation Calculator to see how your savings are faring against inflation.
Inflation is usually measured by an 'index', a number that reflects the cost of a typical basket of goods and services consumed by the public. For example, I could make
my own basic index by calculating that my outgoings on food, fuel, utilities, mortgage and council tax this month are £1,000. Let's divide this by 10 and make my starting
index 100. Suppose a year from now the identical monthly outgoings cost £1,050, then my index will be 105 and annual inflation 5%.
In the UK inflation is calculated each month by the Government's National Statistics department, which has two main measures:
| Index |
What Does It Cover? |
| Retail Price Index (RPI) |
Over 650 items relating to Food, Alcohol, Tobacco, Housing, Fuel & Light, Household Goods & Services, Clothing, Personal Goods & Services,
Motoring, Travel and Leisure. |
| Consumer Price Index (CPI) |
As per RPI but excludes Mortgage Interest, Council Tax, Home Insurance and Vehicle Tax. |
RPI is the traditional measure and normally used when linking pensions, tax allowances and state benefits to inflation. [You might also come across RPIX, which is RPI
excluding mortgage interest]
CPI is the measure used for the Government's inflation target (set at 2% in December 2003) and is comparable across other European countries as it's calculated using
an agreed set of rules.
The proportion (or 'weighting') of each item is intended to reflect a typical consumer and revised once a year to keep it up to date. Of course few of us, if any, are
'average', so if you want a clearer idea of how inflation affects you could try using the National Statistics Personal Inflation Calculator.
The monthly inflation figures are published on a Tuesday, usually around the middle of the month.
How safe is my money?
After you've deposited your life's savings with a bank or building society, what's to stop them running off with your money?
In addition to confirming their responsibilities via a list of terms & conditions (i.e. the small print) when you open an account, the bank or building society
should also be signed up to the Banking Code. This is basically an industry code of conduct that, amongst other things, says the bank/building society will act responsibly and take steps to
safeguard your money.
In the unlikely event that the bank or building society is unable to repay your money (e.g. Landsbanki Icesave & Kaupthing Edge), they will be declared 'in default'. Provided the firm was
authorised in the UK by the Financial Services Authority (FSA) you should then be eligible for some
compensation under the Financial Services Compensation Scheme (FSCS). The FSCS is funded by the financial companies themselves, via annual 'levies' set via the FSA.
The FSCS protects 100% of the first £85,000 of your total deposits held with the financial institution in default. This is per person, so the
figure effectively rises to £170,000 on a joint account. If a claim is triggered then you should receive compensation within 20 days.
Note: the FSCS cover applies to each financial institution registered with the FSA, so if one bank owns another the £85,000 limit applies to both collectively, NOT
individually. Beware of this when opening accounts with different banks and building societies totalling more than £85,000.
The table below shows the more popular banks and building societies that are part of the same institution. If you have accounts with more than one provider within an
institution you'll only be covered for up to £85,000 for that institution in total, not per provider.
| Institution |
Providers |
| Santander |
Santander, Bradford & Bingley, Alliance & Leiceser, Cahoot, Asda. |
| Bank of Scotland |
Bank of Scotland, Halifax, Intelligent Finance, Birmingham Midshires, Saga, AA. |
| Barclays Bank |
Barclays Bank, Woolwich. |
| Lloyds TSB Bank |
Lloyds TSB, Cheltenham & Gloucester. |
| Royal Bank of Scotland |
Royal Bank of Scotland, Virgin Money, Direct Line. |
| Nationwide |
Nationwide, Cheshire BS, Derbyshire BS, Dunfermline BS |
| Skipton BS |
Skipton BS, Scarborough BS. |
| Yorkshire BS |
Yorkshire BS, Chelsea BS, Barnsley BS |
It's common nowadays for foreign banks to market accounts in the UK. Are such accounts as safe as those with a UK bank? There's three scenarios:
Fully covered by FSCS
Provided the bank is regulated by the FSA and a member of the FSCS then you'll enjoy the same level of protection as a UK bank account, i.e. 100% of the
first £85,000 of your total deposits.
Covered by home country compensation then FSCS
If the foreign bank is operating the account under the European Economic Area (EEA) 'Passport' scheme and the compensation limit in its home country is lower than that
under the FSCS, then you're covered by the overseas scheme with the FSCS subsequently making up the shortfall to £85,000. While this sounds like a lot of hassle, in
practice it should have little effect on how quickly you receive your compensation.
This is the process that kicked in during 2008 when Iceland's Landsbanki bank defaulted, leaving around 300,000 Icesave customers having to claim. This was actually more
complicated as Iceland's compensation scheme refused to pay out, pushing the full burden onto the FSCS (and ultimately the British Government that agreed to cover amounts in
excess of the (then) £50,000 compensation limit).
Covered by home country compensation only
If the home country compensation limit of a bank operating under the EEA Passport scheme is greater than that under the FSCS, you will only be covered by the foreign scheme.
The same is also true if the bank is not regulated by the FSA. In both cases, it's just as if you had opened the account directly with the bank overseas.
| AkBank | Netherlands |
|
|
| €100,000 |
| Allied Irish Bank (UK) | Ireland |
|
|
| N/A |
| Anglo-Irish Bank | Ireland |
|
|
| €100,000 |
| Bank of Ireland | Ireland |
|
|
| €100,000 |
| Bank of Ireland (UK) | Ireland |
|
|
| N/A |
| Citibank | US |
|
|
| N/A |
| FirstSave | Nigeria |
|
|
| N/A |
| ICICI | India |
|
|
| N/A |
| ING Direct | Netherlands |
|
|
| €100,000 |
| Post Office | Ireland |
|
|
| €100,000 |
| State Bank of India | India |
|
|
| N/A |
| Triodos Bank | Netherlands |
|
|
| €100,000 |
Catches
If it looks too good to be true it almost certainly is! Some banks and building societies are very slick at marketing, using dazzling rates to tempt in new customers.
This is no crime in itself, in fact it can be a good thing provided you're aware of any potential catches. For example, the rate might include a temporary bonus that only lasts a few months. Typical catches to watch out for are
highlighted on the pages in this section.
Savings jargon
Here's some of the more common savings jargon you might come across:
| 5% Withdrawal | The amount of your initial GIB investment that can be withdrawn each year with no tax liability at that time (it's calculated at maturity). |
| AER | Annual Equivalent Return. Shows the yearly interest you'd receive on your savings assuming interest is compounded over the year. |
| BACS Payment | A direct payment from one bank account to another using the Bankers' Automated Clearing Service. Usually takes three days to clear. |
| Bank of England Base Rate | The rate of interest at which the Bank of England lends to ther banks, reviewed monthly. It's the Bank of England's key weapon for trying to influence the economy. |
| Cash (ATM) Card | A card that allows you withdraw money from cash machines. Might also double up as a debit card. |
| CHAPS Payment | A direct payment from one bank account to another using the Clearing House Automated Payment System. Usually clears same day. |
| Cheque Book | A paper based way of making a payment from your bank account to another. |
| Chidren's Bonus Bonds | A National Savings fixed term savings product for children. Interest is tax-free and fixed. |
| Cleared Balance | Money that is in your bank account, cleared, and ready to use. |
| Compound Interest | Interest earned on interest, e.g. if a savings account pays interest monthly you'll earn interest on interest paid in previous months. |
| CPI | Consumer Price Index. A measure of UK inflation, excludes housing costs such as mortgage payments. |
| Debit Card | Allows you to pay for items like a credit card, but the money is taken straight away from your bank account, just like a cheque. |
| Direct Debits | Payments made on a regular basis (e.g. bills) that are taken directly from your account on an agreed date. |
| ERNIE | The 'Electronic Random Number Indicator Equipment' used to draw the monthly prize numbers for premium bonds. |
| FPS Payment | A direct payment from one bank account to another using the Faster Payments Service (introduced in 2008). Usually clears same day. |
| FSCS | Financial Services Compensation Scheme. Protects savers, up to certain limits, from their bank or building society being unable to repay their savings. |
| Introductory Bonus Rate | A marketing trick used by some banks and building societies to offer a high initial savings rate, which is likely to fall when the bonus ceases. |
| National Savings & Investments | NS&I is a government backed business that offers a range of savings products, most famously premium bonds. |
| Notice Period | The period of time that some savings accounts require you to give notice when you want to withdraw money. |
| Premium Bonds | A government backed savings product where the return depends on winning tax-free prizes in a monthly draw. |
| R85 | A HMRC form that allows non-taxpayers to receive their savings interest without tax being deducted. |
| Regular Saver Bonus | A savings account that offers a very high rate of interest if you save a regular amount each month, typically for a year. |
| Restricted Withdrawals | Some savings accounts restrict the number of times you can withdraw money each year. |
| RPI | Retail Price Index. A measure of UK inflation, includes housing costs such as mortgage payments. |
| Savings Certficates | A National Savings fixed term savings product, available with a fixed rate of interest or a return linked to inflation. Returns are tax-free. |
| Standing Orders | Payments that are made direct from your bank account to someone else on a regular basis. |
| SWIFT Payment | A direct payment from a bank account to an overseas acount using the Society for World-wide Interbank Financial Telecommunications service. Can take up to six days or more to clear. |
| TESSA | Tax Exempt Special Savings Account, the forerunner to cash ISAs. |
| Tiered Interest | Savings account interest rates that vary depending on your balance. |
| TOISA | Tessa Only Individual Savings Account, a type of ISA available for money from maturing TESSAs, now extinct. |
| Top Slicing | The method by which the amount of tax owed, if any, is calculated when a GIB matures. |
| Uncleared Balance | Includes money due to arrive in your bank account that has yet to clear. Money must normally clear before you can get your hands on it. |