How to make the most of savings

Savings options in the UK include ISAs, easy-access savers, notice or fixed-rate savers and regular saving accounts.

All basic-rate taxpayers can earn up to £1,000 in interest per year before they need to pay tax on it, while up to £20,000 can be transferred into a cash ISA in each financial year.

Many households will benefit from an approach that combines several savings options across several financial providers.

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How to start saving

Opening savings accounts and putting money aside for the future can help us buy the things we need and want, as well as ensuring we've got a nest egg in case something goes wrong.

There are a few things to consider before we start saving:

1. Are there any debts we should pay off first? It's usually better to pay off debts first because they have higher interest rates than those we will earn on savings, plus banks can sometimes take money from our accounts to pay our debts in rare circumstances.
2. Are we looking for easy-access savings or something longer term?
3. Is there a maximum amount we're able to put into a savings account upfront?
4. How much can we afford to save per month and is that likely to go up/down?

For saving to be effective, we need to understand our financial situation clearly and create a budget that works, perhaps using the backwards budgeting method.

Savings work best when kept away from our everyday finances, and that's why many people choose to set-up standing orders just after payday to transfer money straight into their savings account before they've had chance to think about spending it.

The most suitable type of savings account will depend on an individual's circumstances.

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What are the different types of savings accounts?

There are various choices available when we want to put money into a savings account such as:

• Cash ISAs
• Regular savers
• Fixed-rate savers
• Notice savers
• Easy-access savers

As we explore, there are pros and cons to each of the saving options on offer, and it's possible to have a combination of these accounts. However, customers should be aware of how much they're saving in total to check if they are going to be any tax implications.

Let's take a closer look at the options.

Cash ISAs

Cash ISAs are individual savings accounts that never charge tax on interest (there's more on tax and savings later in this guide).

There are various types of cash ISA that mimic some of the other savings account options we cover below:

• Fixed-rate cash ISAs
• Notice cash ISAs
• Easy-access cash ISAs

Up to £20,000 can now be saved per tax-year across all different types of ISA, an increase from the £15,000 per year allowance at launch in 2014.

Crucially, the money in an ISA remains tax-free as long as it stays in there. This means we can save up to £20,000 per year without being taxed, with the tax-free lump sum growing the longer we continue paying money into the ISA. That's why using as much of the allowance per year as possible is usually recommended.

That said, cash ISAs don't have the same appeal to small savers anymore due to the Personal Savings Allowance introduced in 2016 that allows us to earn up to £1,000 in tax-free interest.

If a saver is going to earn more than that amount in interest or are a higher rate taxpayer, cash ISAs could still provide a good option for tax-free saving.

One thing to note about cash ISAs: they can be transferred to get a better rate of interest, but it's important that it is transferred to another ISA location and not withdrawn to a current account or elsewhere - this will result in losing the tax-free status on that money.

Regular savers

Regular savings accounts require customers to deposit money into the account each month and usually offer better rates than the fixed or easy-access savers we look at below.

There are some key factors to remember when looking at regular savers:

• You have to deposit a certain amount each month
• If you fail to make a deposit, the interest may be lost or the account closed
• The money is untouchable for the length of time agreed
• Regular savers start from zero balances
• Interest is calculated and applied to the balance monthly, meaning the headline interest rate is actually around half the quoted rate over the lifetime of the term

It's also worth highlighting the fact that regular savings accounts tend to drop the interest rate after a set period (12 or 24 months), so withdrawing the money at that point is a good idea.

The rates on regular savers aren't as good as they were in the past, plus the hassle of withdrawing at the end of a term to move elsewhere can put some people off.

However, if we're looking for a simple way of transferring money from a current account into a savings account via a standing order, this is a good option - even if Open Banking means digital challengers may offer more flexible ways of doing that.

Fixed-rate savers

Fixed-rate savings accounts, also known as fixed-term bonds, require customers to lock away their savings for a set amount of time.

These accounts come with a fixed interest rate as the name suggests, meaning customers are guaranteed to get that rate throughout their saving term.

Often, fixed-rate savers will have better interest rates than we see for easy-access accounts, but there are a few things to highlight:

• No extra money can be deposited throughout the fixed term, so the amount you put in initially is the only deposit allowed
• No withdrawals can be made during the fixed term
• Many fixed-rate savers have a minimum saving amount so customers must be able to deposit a major lump sum at the outset

Banks are able to offer higher interest rates because of these restrictions. From their perspective, they have the certainty of knowing that your money will be with them for a long period of time (and that's why it was reported in 2014 that they dislike customers constantly switching for better rates). However, this does limit the options for customers if their circumstances change.

12-month or 24-month fixes are common, although there are longer deals out there.

Customers should carefully weigh-up whether they want to lock their money away in one account for longer periods, especially since interest rates can change and what looks like a good deal now may not be in three years. That said, other customers may prefer the certainty of knowing how much they can expect to receive when the fixed term matures.

Notice savings accounts

Notice savers aren't as popular as they used to be. These savings accounts act as a bridge between fixed-rate and easy-access savers, generally offering good interest rates to customers with the caveat that any withdrawals must be applied for beforehand.

We see notice accounts that want customers to give 30 days' notice of withdrawals all the way up to 180 days (six months) and there will likely be minimum and maximum amounts that limit how much a customer can pay into the account.

While notice savers used to be a great alternative for customers who didn't want to completely lock their money away but still wanted a better rate, they don't have the same impressive interest rates as they used to and generally come with variable rates that require customers to keep an eye on them in case they need to move their money.

So, notice accounts come with fewer guarantees than fixed-rate savers and are less convenient than easy-access savers.

Easy-access savers

An easy-access saver is an account that allows customers to make withdrawals quickly and easily.

There is no fixed term or notice period, so customers have rapid access to their savings in case they need to get their money back.

Although some easy-access savers come with eye-catching introductory rates, these will generally drop sharply after the introductory period and customers may want to shop around for a better deal.

In addition, the interest rates on easy-access savers are not as generous as fixed-rate deals, but some customers will prefer flexibility over higher returns, especially if they think they might need their money back quickly.

What about pensions?

Saving money for retirement through a pension should be a priority to help us retire comfortably.

Pensions are often heralded as the best way to save for the long-term, although there are differences to the saving methods detailed above because pensions are locked in until we retire.

We've got more on that in our guide to pension options at retirement, and it's also important to understand the different types of pension schemes available (and any changes made to the law since the pension was taken out).

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Savings and tax

Thanks to the introduction of the Personal Savings Allowance in 2016, we can earn £1,000 in interest from our savings if we're a basic-rate taxpayer.

Any money we earn in interest above this level will be taxed at our usual rate (20% basic-rate, 40% higher-rate or 45% additional-rate).

This is how that looks for a basic-rate taxpayer:

Remember, this is tax on the amount of interest earned, and that's unlikely to apply to many people unless the interest rates on their saving accounts are huge.

The introduction of the Personal Savings Allowance means that some of the tax advantages of choosing a cash ISA over other types of saving accounts are more limited than they used to be.

As we've explained above, higher-rate taxpayers or those who are earning lots of interest will still benefit from a cash ISA, but the allowance gives us more leeway when it comes to keeping hold of interest on our savings.

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Are savings protected?

If savings are held with a financial provider regulated by the Financial Conduct Authority (FCA) and covered under the Financial Services Compensation Scheme (FSCS) then up to £85,000 is protected per person per institution.

So, in the unlikely event the savings account provider collapses, £85,000 of our savings will be backed by the Government.

If we have multiple accounts with the same provider, only £85,000 will be protected, but if we have several accounts with different providers, £85,000 will be protected across each account.

This is why experts will generally advice customers to spread their savings between banks to ensure they're fully protected.

Read more about savings protection or find out which banks belong to the same groups (and share the same banking licences).

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Can saving beat inflation?

In an ideal world, we would want savings to be growing faster than prices. If that doesn't happen, it means our savings will be worth less in real terms when we withdraw them.

The Consumer Price Index (CPI) rate of inflation rose to 7% in March 2022. With inflation at that level, it's unlikely there are going to be safe and legitimate savings accounts offering interest rates that can keep up.

That said, having money in a savings account with any sort of interest is better than keeping them in a current account where they won't gain any interest at all and where we might be tempted to dip into them.

With inflation set to remain high for some time, it could be a while before savings are able to outstrip it again.

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How much are we saving?

Warnings that we're not saving enough are issued regularly, with many households simply not having the means to survive financial shocks by relying on their savings for a while.

The Office for National Statistics keeps track of how much of our disposable income we're managing to save. Here are the annual figures for the past five years:

The spike in 2020 was due to the coronavirus pandemic and the fact that people were saving rather than spending their disposable income on holidays, nights out and the like.

Yet a look at 2021 shows a clear downward trajectory:

With the cost of living rising, it's likely that the amount of disposal income we're able to put into our savings will decrease even further in 2022.

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Summary: Be savings aware

Thanks to the number of options available, savings accounts can seem overwhelming and confusing.

Working out where is best to put your money to earn the maximum amount in interest isn't straightforward and the right choice for you will depend on various factors including:

• How much access you need to your savings
• How much you want to save
• Whether you can afford to save the same amount per month
• Whether you want to deposit one lump sum or make multiple smaller deposits
• Whether higher interest rates matter more to you than flexibility and accessibility

For most people, the result is going to be a combination of accounts held across different institutions (to keep that money safe).

Remember the following points:

1. £1,000 in interest gained on our savings is tax-free
2. Up to £20,000 per financial year can be deposited in a cash-free tax ISA
3. Easy-access savings accounts are the most accessible followed by notice accounts, regular savers and fixed-rate accounts

Saving options have evolved since the FCA warmed of so-called zombie accounts that weren't working for customers in 2015, and many savers now have a greater understanding of the ways their money could be working for them thanks to Open Banking and platforms designed to help us manage our finances more effectively.

Even so, with the cost of living crisis set to dominate household finances over the coming year and beyond, paying off debts and saving smaller amounts might be the closest households get to making the most of their savings accounts.