Are you happy with your savings account? If you are you probably think that the magic of compounding is quietly increasing the value of your stash as you sleep. You are probably wrong. Half of the savings accounts in the UK pay less than 0.5% interest. With inflation as measured by the CPI running at 3.2%, that means your money is losing purchasing power by the minute. It also means you need to do something about it.
It may be that when you opened you account the interest rate was fine. But interest rates rarely stay good. Why? Because as a nation we are notoriously lazy when it comes to our finances: we very rarely switch bank accounts. So banks know they can lure us in with attractive interest rates and then after about a year get away with dropping the rate – to a shocking 0.1% for a quarter of savers, according to an investigation by Which?
So what should you do?
Check your rate
The first thing to do is check what interest rate you are getting on your savings accounts. Banks and building societies have come under fire for not clearly showing the interest rate on statements. To counteract this Which? has launched its ‘saving rates booster‘. You just tell it how much you have saved, who operates the account and what the account is called and it will tell you what your interest rate is. So, for example, if I had £5,000 deposited in the FirstDirect Everyday Savings account then I would be earning 0.1% interest.
Make your savings earn more
Once you know your savings rate, you’ll almost certainly want to switch accounts. I’ll eat my hat if anyone has a savings account they opened more than a year ago that is still paying a decent rate – except for fixed rate bonds of course – if I’m wrong you can let me know on Twitter, I’m @RuthMoneyWeek.
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Now for some bad news: there aren’t any savings accounts offering particularly amazing rates of interest at the moment. Instead most accounts are failing to even keep up with inflation. You need to be getting an interest rate that compensates you for both inflation and tax in order for your money to actually grow in terms of purchasing power. For example: you put £100 in a savings account paying 2% interest and you leave it there for a year with the intention of buying a £100 holiday. By the end of the year you’ll have £102. That might seem nice, but inflation will mean your holiday will cost £103. So you will have lost, not gained, in ‘real’ terms.
If you factor in the tax you’ll pay on interest, then a basic-rate taxpayer needs an account paying 4% in order to beat inflation, and a higher-rate taxpayer needs an account paying 5.3%. Unfortunately, there isn’t a standard savings account on the market offering an interest rate of 5.3%.
That leaves basic rate tax payers with a few options. You can get 4.5% interest with United Trust, AA, ICICI, SAGA and the State Bank of India. But to do so you have to lock up your money for five years with all of them. That’s not something I would recommend. Interest rates will eventually rise, and when they do you will want to be able to move to a higher rate account as soon as they hit the market.
Don’t forget about Isas
A better option is to make the most of your individual savings account (Isa). Everyone is allowed to put up to £5,100 a year into an Isa where it can earn interest tax-free. That means all taxpayers – even those on 40 or 50% marginal rates – only need a rate of 3.2% for their growth to outpace inflation. So lock up your money for three years with Northern Rock’s fixed rate Isa issue 148, which pays 3.35%, and you’ll still be making money.
That said, the difference between making a real return and not making one is marginal: inflation only has to move to 3.4% and you’ll be losing again – and stuck in a three year deal (you can withdraw your cash but you’ll pay a penalty).
That means it may be that the best any of us can do is to get the best possible short-term savings rate we can, and then be on the lookout for something better. Bank offers are already creeping up a little, but as soon as interest rises they will leap. Then you can jump in and get a good deal.
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