By Rachel Williams from Interactive Investors
Thursday, February 04, 2010.
Editor’s note: This article is targeted at UK-based readers. Please seek expert opinions before making financial commitments.
Savings accounts aren't exactly exciting. While you might hear people bragging about the money they've made on the stockmarket, it's unlikely you'll hear anyone exulting the return on their savings account. This is because savings are safe - you pay your money in and sit back and relax, safe in the knowledge your money will grow. However, this inertia is costing us.
While there are plenty of accounts out there paying around 5%, there are many more paying much less - some less than 1%. "The rule of thumb is, if it's got 'Gold' in the title it's paying brass," warns Matt Pitcher, an IFA from Towry Law.
Originally these accounts were competitive but as institutions withdraw them in favour of new launches, the rates slip. So even if you did once shop around, you could now be losing hundreds of pounds. To put that into perspective, if you have £10,000 in one of the high street's worst offenders paying 0.6% you'll earn just £60 a year before tax. Switch it to one of the best deals and you could earn £500.
So whether you are reviewing your savings or starting afresh, it's worth making sure you don't undermine your efforts to save by holding it in the wrong account. With more than 4,000 accounts available this can seem like a daunting task.
However, once you know what you are looking for it's relatively straightforward to track down the best deals - using websites like Interactive Investor or in the best buy tables found in the national press.
The starting point should always be a mini cash individual savings account. "Everyone should have one," says Rachel Thrussell, head of savings at Moneyfacts. "You can pay in up to £3,000 a year and the interest is tax-free."If you've used your ISA allowance you need to look at alternatives. Interest is clearly important but you should look beyond the headline rate. There's no sense in a fantastic rate if you can't get your hands on your money when you need it. Bonuses are another trap. Banks frequently offer bonus rates for six months or so to get their account into the best buy tables before dropping it to one that's altogether less appealing."
So if you want to benefit from these rates, make sure you jot down in your diary when the rate drops. Do remember though that banks don't have to accept you as a customer and they are starting to clamp down on 'rate tarts' who take advantage of bonuses and then move their money elsewhere. "If you've already had an introductory bonus, leave and then try to come back for another, some institutions won't let you," explains Thrussell. Northern Rock and Scottish Widows are two banks that have started to do this, she adds.
As Matt Pitcher points out, however, most people have neither the time nor the inclination to keep switching. If this is the case you need to look for rates that may be lower but at least more likely to be maintained. "Look out for the annual equivalent rate (AER) as this strips out the initial bonus," he advises. "I'm a big fan of ING Direct. It's only paying 4.5% but it is consistent."
Thrussell adds it may also be worth checking out some of the small building societies - again rates may not be the best, but they have a reputation for consistency.
The savings market today is so competitive - with the online banks keeping the high street on its toes - that you don't necessarily have to sacrifice access for higher rates. Although historically notice accounts and those that tie up your money for a year or more have paid more, that gap is closing and many feel that even if you do get a slightly higher rate it's unlikely to be worth the loss in flexibility.
However, while instant access is the best option for most, that doesn't mean they are always transparent. It's essential to check that you aren't penalised for withdrawals. HSBC and First Direct, for example, both offer an attractive rate of 4.75% - the catch is that you don't earn any interest in any month you make a withdrawal.
Another option to consider is a savings account which rewards savers who can commit to saving a fixed sum every month for a year with the highest rates on the market - up to 10%. Sue Hannums, savings manager at independent financial adviser AWD Chase de Vere, is a big fan of these accounts. "It's a great way of getting the savings discipline. Even £20 a month might be all it takes to stop you needing a credit card at Christmas."
However, once again, she says you need to watch for the catches. Halifax and Abbey, for example, both pay 7% but the penalties are severe if you miss a payment and you can't touch the money for a year. Alliance & Leicester and Barclays, meanwhile, pay 10% but in addition to the aforementioned ties you also have to hold your current account with the bank. This is great for existing customers, but experts usually agree that you shouldn't switch current accounts just for the sake of a one-year savings deal.
Alternatively, if you have a large amount in savings you may want to take a more radical approach and use an offset mortgage. By combining your mortgage with your savings account (and/or current account) you're able to offset your savings against your debt meaning you only pay interest on the remainder. Matt Pitcher likes this option. "Whenever you have a surplus you can sweep it into your savings account which means you can save money on interest and reduce the term of your mortgage." This can be attractive to higher rate taxpayers who see much of their savings interest disappear in tax.
A thorough savings review isn't just about ensuring your money is in the right vehicles, however. In addition to taxpayers making sure they're making the most of their annual ISA allowance, non-taxpayers need to make sure they're not shelling out unnecessarily. Tax is automatically deducted from savings accounts unless you inform your bank that you aren't a taxpayer. This can be done by completing form R85 - available from HM Revenue & Customs, banks and building societies.
Finally it's worth making sure savings is still the right home for your money. If you have enough rainy-day money - conventional wisdom suggests between three and six months' salary - and enough for any known expenses such as a car or house deposit, it may be worth looking at more profitable investments. "If you can tie your money up for between five and 10 years you should get a better return on the stockmarket," says Justin Modray, an IFA from Bestinvest. And if you're nervous about stockmarkets? "Even fixed interest products like bonds and gilts or commercial property are likely to earn you more."
With thanks to Interactive Investors.
Rate Alert - Top Savings Deals
Citibank Flexible Saver - 5.04% AER
Birmingham Midshires Savings - 5.0% AER
Capital One Savings - 4.8% AER
First Direct e-Savings - 4.75% AER
Halifax Web Saver - 4.75% AER
Compare over 2,000 savings accounts