A savings account is somewhere for you to put the money you don’t want to spend, and the bank will pay you interest for keeping it with them.
How does a savings account work?
Put your money into a savings account and you are giving it the chance to grow. That’s because savings accounts pay you a percentage of your balance as interest. How much interest you earn on your savings varies depending on the savings account and how much you’ve saved, but even a small amount can help you achieve your savings goals as interest builds.
For example, if you put £1,000 into a savings account that pays 2% interest, after 12 months you would have £1,020. Then, after five years you would have about £1,100. That’s assuming you didn’t save any more money in that time. If instead you paid in £100 a month for five years on top of the initial £1,000 lump sum, saving a total of £7000, you would earn about £400 extra in interest.
Traditional savings vs Cash ISAs
The first decision you need to make when choosing a savings account is whether you want a tax-free account or not.
Traditional savings accounts are taxed. You pay income tax on the interest you receive in your account if it exceeds the personal savings allowance. A basic-rate taxpayer can earn up to £1,000 in interest a year. If they earn more than that, they will have to pay income tax on the excess. A higher-rate taxpayer has a £500 allowance, and an additional rate taxpayer gets no allowance at all.
The alternative is an Individual Savings Account, or ISA. Money held within an ISA can grow tax-free no matter how much interest you earn. But, you can only open one cash ISA per tax year and the most you can pay in is £20,000 a year (in the 2020/21 tax year).
Once you’ve decided whether to go for a traditional account or cash ISA, you then need to decide what type of account to get.
» MORE: Is an ISA or savings account best for you?
Types of savings accounts
There are many different types of savings accounts. Some will reward you for locking your money away for a longer period, others reward you for saving regular amounts and some will protect your money from tax.
Ask yourself a few questions to work out which type of account might be best for you:
- When will you need the money?
- Will you pay tax on the interest earned?
- Do you need instant access or are you prepared to give notice before you withdraw your money?
Here are the basic types of savings accounts
Easy access savings accounts
Also called instant access accounts, easy access savings accounts do exactly what the name says on the tin – you get easy access to your savings. That means you can make deposits and withdraw your cash whenever you want.
All that ease comes at a price though – you usually get the lowest interest rates on easy access savings accounts. Some instant access accounts may limit the number of withdrawals you can make each year to discourage you from repeatedly dipping in.
Notice savings accounts
If you want a slightly better rate of interest than you can get on an easy access savings account – but still want to be able to get at your money – then a notice savings account could be the answer.
These accounts allow you to make as many deposits and withdrawals as you like but you have to give notice before you can withdraw your money. How much notice depends on the account but it is usually between 30 and 180 days.
If you need your money in a hurry, then you’ll typically lose some interest as a penalty.
Regular savings accounts
Anyone looking to get into a savings habit should consider a regular savings account, or regular saver. You have to pay some money into your account every month and if you miss a month your interest rate will drop.
Regular savings accounts usually last for one year and put a limit on how much you can pay in each month. Some accounts may require that you pay in as much as several hundred pounds a month. Most accounts also put a limit on withdrawals. This can make regular savers a good framework for building a nest egg.
Some of the best-paying regular savers are often linked to current accounts and not open to all savers, so if this type of savings account appeals to you it’s worth considering whether you’re interested in a new current account, too. These interest rates are often variable so returns are not guaranteed.
Fixed-rate bonds give you a fixed rate of interest for a set period of time. During that time, you can’t withdraw your money without losing some of the interest as a penalty. Fixed-rate bonds are usually available over one- to seven-year periods and the longer you are prepared to tie up your money, the more interest you could earn.
How to get a savings account
You can apply for a savings account in your local bank or building society branch, online or sometimes over the telephone or by post.
When choosing a savings account, check if there is anything you are required to have in order to open an account. For example, some savings accounts can only be opened if you have a current account with the same bank, and smaller building societies may only offer their products to people in the local area. There may also be minimum opening deposits; these can range from as little as £1 to as much as £10,000
Is it worth putting money in a savings account?
With interest rates remaining low, you may be disappointed by the deals on offer but it’s important to not let this put you off. Paying money into a savings account each month is a healthy habit that removes the temptation to spend your spare cash, reduces your need to borrow and increases your overall financial security.
When choosing a savings account, it is important to get the highest rate of interest you can, with the flexibility and access that you need.
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