Explaining the Different Types of Savings Account
We can all understand the importance of putting aside a little bit of money each month to grow our savings, whether it is for a rainy day, for a big purchase like a new car, or for retirement. However, it can also be difficult - unexpected bills, increasing living costs and spontaneous purchases can eat away any spare money.
What you can control is which savings account you choose to keep your money in, ensuring your savings are working as hard as they can to earn you interest. As well as the highest return, other factors to consider when choosing an account include how often you will need access to the money, how tax-efficient the account is, and what your savings goals might be.
There are hundreds of different accounts and companies to choose from, including high street lenders you may already bank with and online start-ups offering innovative new products. Below we have looked at the different types of savings account available to help explain the key differences and benefits of each.
Short Term Savings Accounts
You may not be in a position to keep your money tied up for the long term, for example if your cash flow is unpredictable you may need to dip into your savings, in which case you may wish to choose a form of ‘instant access’ account. The majority of these accounts will let you withdraw money as soon as you need it – usually with a card that can be used at cash points. Other accounts may take a bit longer to transfer your money, so if you are likely to need access within 24 hours you should look closely at the terms and conditions.
Instant Access accounts offer a more flexible approach to saving and should give a more favourable return than keeping the money in a current account. On the flip side, you will not enjoy the same kind of interest rates and benefits of longer-term savings accounts and there may also be conditions that limit the amount you can withdraw during a certain period.
Short term savings accounts are beneficial for people who cannot take on the commitment of long terms savings and investment products and they can also be used in conjunction with other savings products. For example, rather than having just a current account and a long term account, you could add an instant access account to bridge the gap, earning interest while adding flexibility.
Long Term Savings Accounts
There are different forms of long term savings accounts – on one hand there is something like a fixed-rate bond that requires you to commit your money for an agreed period, on the other hand there are regular savings account where you agree to deposit a certain amount each month over a period of time.
The upside of these types of account is that in return for you committing to save a certain amount, whether it’s as a lump sum or regular payments, you should get a higher rate of interest. It may be difficult to predict what your financial situation will be in the long-term, especially when it comes to savings bonds that last for five years, but if you think of it like an investment, the amount of time and commitment needed make more sense.
Savings bonds can be fixed-rate or can track a specific index such as the Bank of England base rate. Fixed rate bonds offer a specific interest rate over a specific period i.e. six months, a year, two years. Tracker bonds offer a base rate that can go up or down depending on what it is tracking. Essentially the difference is one of certainty – with fixed rates you know what to expect, with trackers there is the potential of higher and lower returns.
Regular saver accounts may also be a good option for people looking to get into the habit of saving, who do not already have a lump sum to invest. However, it is important to remember that not keeping up with payments can lead to penalties and a reduction of your rate.
Individual Savings Accounts
ISAs are products that allow you to save without paying tax on the interest you accumulate, up to a certain amount each year. From April 2016 things in the UK have changed slightly as the government introduced a personal savings allowance of £1000 (or £500 for higher rate taxpayers) – meaning you pay no tax on interest up to a total of £1000 or £500. The vast majority of people in the UK would not have enough savings to earn £1000 in interest in a year and as such, it means very few people will need to consider the tax implications of saving.
This change may seem to lessen the usefulness of ISAs – if you won’t be paying tax anyway, why bother with an ISA? Well, firstly any interest earned from an ISA will not count towards your individual savings allowance, so if you were near to the threshold you could save even more without paying tax. Secondly, ISAs come in many different forms – there are cash ISAs, Stocks and Shares ISAs, Help to Buy ISAs (which help prospective first time home-owners) and Junior ISAs for children.
ISAs may no longer be as essential for savers looking to reduce their tax bill, but it may still be worth seeing what products are on offer in case they suit your particular set of circumstances.
Peer-to-peer lending is something that has emerged over the last few years – partly because new technology has allowed its growth and partly because small businesses and borrowers found it more difficult to find lenders in the wake of the credit crunch.
It is up for debate as to what extent peer-to-peer lending is saving or investing – as Martin Lewis says it is more a “hybrid of the two”. Companies like Zopa, Funding Circle, and Lending Works use their algorithms to match you, the saver or ‘lender’, with someone who needs a loan. You would not be lending on a one-to-one basis – your money will be spread over hundreds of loans in small amounts, along with your fellow savers.
Much like with a long-term savings account you are offered a certain rate as long as you are willing to commit your money for a certain period. Because of the investment nature of this type of account, interest rates can be quite favourable and can be attractive option for savers more willing to experiment.
If you’re interested in peer-to-peer lending, you’re now better protected as the industry became regulated by the Financial Conduct Authority from April 1, 2014. However, there’s no safety guarantee; with normal UK savings, the Financial Services Compensation Scheme will pay the first £85,000 per person, per financial institution if the company goes out of business. However, peer-to-peer lenders don't have this safety net, even now they're regulated.
The rules state that peer-to-peer firms must present information clearly, be honest about risks and have plans ready in case things go wrong. All peer-to-peer firms must meet these rules or face sanctions, which can include large fines.
Firms have to have at least £50,000 worth of capital (or more for bigger firms) in reserves to act as a buffer to ensure they can withstand financial shocks or difficulty.
If you are interested in learning more about your finances, you can get online access to your credit history with the FREE Equifax Credit Report & Score product which is free for 30 days and £14.95 a month thereafter.
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