Introduction to Saving

What is it?

Saving means tucking away spare cash somewhere safe so you can use it in future.

If you spend less than you earn, chances are you'll have some money to save. Saving is important as, short of a fortunate windfall, it's the only way most of us can accumulate a financial umbrella to cope with 'rainy days' (e.g. building/car repairs, unemployment etc.).

Saving money could mean anything from hiding it under your mattress to depositing it in a bank, but the key is that the cash is safe and that you can get your hands on it when needed. Yes, it is possible to 'invest' the money instead with the prospect of sexier returns; but you could lose out, especially if your 'rainy day' coincides with the investment plunging in value!

Interest

While storing cash in a jar or under a mattress might appeal to some, it's not a very good idea. The money won't grow unless you add more to it.

Much better to 'earn' some extra money, called 'Interest', in exchange for letting someone else use your cash while you don't need it (on the promise they'll return it to you when needed). Of course, you'd probably feel uncomfortable doing so with any old Tom, Dick or Harry, which is where banks and building societies come in.

If you put £100 under your mattress you would still have £100 25 years later.
If you had instead put the cash in a savings account with annual interest of 1.00% it would have grown to around £128 over the same period.

When you deposit money in a savings account with a bank or building society they can use this to lend to someone else, perhaps via a loan or mortgage. They profit by lending out your money out at a higher interest rate than the one they're paying you (the difference is known as the 'interest margin').

Interest, which is usually paid either monthly or annually, is quoted as an annual percentage rate before any tax is deducted (i.e. 'gross'). For example, an interest rate of 1.00% gross per annum (p.a.) means you'll receive £1.00 each year for every £100 held in your account.

Accounts that pay interest monthly usually pay a slightly lower rate of interest than a comparable account paying annual interest. This is due to compounding. However, fear not, banks and building societies must show both the actual interest rate and the Annual Equivalent Rate (AER), which factors in compounding.

Don't ignore debts!

Because banks and building societies profit by lending out your money at a higher interest rate than the one they're paying you, it's rare to earn a higher rate of interest on your savings than you'll be paying on your debts.

A basic rate taxpayer putting £1,000 in a savings account paying 1.00% gross p.a. for 3 years would earn around £24 of interest after tax. If they also had a £1,000 debt on a credit card at an annual interest rate of 18.00%, they would have paid nearly £643 of interest after 3 years (ignoring minimum monthly payments). Saving at the expense of paying off the credit card could cost this individual around £619!

Therefore, if you have debts, it normally makes more sense to pay them off before you start saving. The only exceptions are if you have free/very low cost debts (such as 0% credit cards or a student loan) or the penalty for paying off the debt early is prohibitive.

Tax

The taxman gets everywhere and your savings are no exception, although new rules from 6 April 2016 have made tax on savings more generous.

Use our Savings Tax Calculator to see how tax affects your savings income.

It's a fallacy that UK taxpayers don't have to pay tax on interest from offshore savings accounts. HMRC requires interest to be declared and tax paid via annual tax returns.

Cash ISAs are tax-free, hence well worth a look for taxpayers.

Inflation

As a saver, inflation is your enemy. Rising prices of goods and services mean that your money will be worth less in future than today, so your savings could fall behind.

For example, if your savings account pays 1.00% after tax and inflation over the year is 1.00% then you're no better off. Worse still, there's a chance that over time the interest you receive on your savings is lower than inflation, especially if you're a taxpayer. This means you might actually be worse off in future!

We're currently in an unusual environment where inflation has, at times, been negative. This means your money would be worth more in future than today. Given this has been accompanied by a period of very low interest rates, there's sadly little reason for savers to rejoice. Also, because the biggest contributor to negative inflation (Retail price Index) has generally been lower mortgage interest rates, there's less impact on savers who've already paid off their mortgage.

Over the year to February 2023, the Retail Price Index rose by 13.5%. At this rate, the cost of goods and services will double over 5 years and 6 months

NS&I Index-Linked Certificates offer a way for savers to combat inflation, as they pay interest over and above the Retail Price Index (RPI). Returns are also tax-free.

Use ourSavings vs Inflation Calculator to see how your savings are faring against inflation.

How safe is my money?

After you've deposited your life's savings with a bank or building society, what's to stop them running off with your money?

In addition to confirming their responsibilities via a list of terms & conditions (i.e. the small print) when you open an account, the bank or building society should also be signed up to the Banking Code. This is basically an industry code of conduct that, amongst other things, says the bank/building society will act responsibly and take steps to safeguard your money.

In the unlikely event that the bank or building society is unable to repay your money (e.g. Landsbanki Icesave & Kaupthing Edge), they will be declared 'in default'. Provided the firm was authorised in the UK by the Financial Conduct Authority (FCA) you should then be eligible for some compensation under the Financial Services Compensation Scheme (FSCS). The FSCS is funded by the financial companies themselves, via annual 'levies' set via the FCA.

The FSCS protects 100% of the first £85,000 of your total deposits held with the financial institution in default. This is per person, so the figure effectively rises to £150,000 on a joint account. If a claim is triggered then you should receive compensation within 20 days.

Note: the FSCS cover applies to each financial institution registered with the FCA, so if one bank owns another the £85,000 limit applies to both collectively, NOT individually. Beware of this when opening accounts with different banks and building societies totalling more than £85,000.

Catches

If it looks too good to be true it almost certainly is! Some banks and building societies are very slick at marketing, using dazzling rates to tempt in new customers.

This is no crime in itself, in fact it can be a good thing provided you're aware of any potential catches. For example, the rate might include a temporary bonus that only lasts a few months. Typical catches to watch out for are highlighted on the pages in this section.

Savings jargon

Here's some of the more common savings jargon you might come across:

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