The smart way to manage a savings account

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From an early age many of us are told that saving — setting aside some of your money for future use, rather than spending it — is a good thing.

But it can be tough to do, especially when you can think of more exciting uses for your money.

So it’s important to know what you are saving for and to set goals for the money. It’s also important to work out the best place to save your hard earned cash.

Why bother saving?

Putting your money in a savings account is a way to keep your cash safe while earning some interest.

One good reason for saving cash in a bank account is to build up an emergency fund. This fund should be enough to tide you (and anyone who relies on you financially) over if you lost your job due to redundancy, or suddenly have to pay for something that you were not expecting. Many advisers recommend that you should have enough in savings to cover your basic expenses for between three and six months.

Another reason is to save up for a special item or event, such as a new car or wedding, or for a property.

Some people like to have savings in cash available so they can take advantage of an investment opportunity if they see it — perhaps in the stock market if share prices have fallen, or in property.

And people who are retired are usually advised to hold up to two years’ outgoings in cash savings (rather than in stock market investments). This means they have money to spend even if the stock market falls.

What to think about before opening a savings account

The alternatives

Savings accounts in a bank are great, but if you can stash your money away for a very long time without touching it, say five years or more, then you should probably think about investing it rather than saving. That’s because the stock market gives your money a chance to grow faster than inflation. The value of your investments might fall, but a longer timeframe means there is more chance of recovery.

It is possible to have too much in savings. In the UK, the Financial Conduct Authority — a regulator whose job it is to make sure that consumers are getting a fair deal — found that there are 7mn people who have more than £10,000 in savings who might benefit from investing instead.

Safety

Not all banks are the same. Some are safer than others and it is not impossible for a bank to go bust. So check what protection is in place for your money if there is trouble.

In the UK, for example, the Financial Services Compensation Scheme protects the first £85,000 you have saved in each UK-regulated bank or building society. In the US, the Federal Deposit Insurance Corporation does something similar.

Interest

This is the big one. Most savings accounts will pay you interest each month in return for you keeping your money there.

But it is important that the interest rate you receive on your savings keeps pace with inflation. If it doesn’t then your savings are actually losing their value — you will be able to buy less with your money in future than you could in the past.

So the key is to shop around to make sure that you are getting the highest interest rate possible. These days you can switch savings accounts relatively easily and quickly.

In the UK, banks usually change their interest rates on savings accounts to match changes to the main interest rate set by the Bank of England, also called the base rate. So if you see a headline saying “the Bank of England has put interest rates up”, that is good news for savers.

Watch out for bonus rates, however. Many banks offer a high interest rate to pull new customers in, then drop the rate after a few months. So you need to keep an eye on any potential changes to the rate that you are being paid, and be ready to switch to a better paying account if necessary.

If you want the best rates, you might need to commit to a particular account for a year or more. Usually, the longer you’re willing to commit, the better rate you’ll get.

But also check how quickly you can take out your money if you need to, and the minimum amount of money you have to put in (either to open the account, or each month).

There is a standard term that shows you the total amount of interest you will receive for one year, which makes it easier to compare accounts. This is AER, which stands for Annual Equivalent Rate. This is the total interest that you’ll receive on your savings in one year. It is shown as a percentage and the higher the AER, the more interest you’ll receive.

Tax

The interest you earn on your savings may be taxed. In the UK, the Personal Savings Allowance (PSA) lets most people earn up to £1,000 in interest without paying tax on it. But the interest from savings beyond this limit may be subject to income tax, which can eat into your returns, and the potential for your savings to beat inflation.

There may be tax-efficient ways to save. In the UK this is done through a cash individual savings account (Isa). Adults can put up to £20,000 a year into a cash Isa, free of tax on savings interest. In France there is a series of tax-free savings accounts called Livrets.