Which type of savings account is right for you?

Investing your money for the future is generally the best way to grow your wealth faster than inflation. But investing is a long-term activity and usually demands you are happy not accessing your investments for at least five years or longer.

If you have any spending plans that fall within the next five years, investing is not the right solution for that portion of your money.

We also recommend you keep three to six months’ essential spending on hand to cover you for an emergencies or short-term financial problems. Call it your rainy-day savings.

But even with the recent rise in interest rates, most bank deposit accounts are still failing to keep pace with inflation. Here we look at alternatives to deposit accounts: specialist cash savings accounts.

How many types of savings account are there?

Most banks and building societies offer different types of savings accounts alongside your chequing or deposit account. There are three main flavours, and in this article we explain how they differ.

1. Instant access savings account

Also known as easy-access accounts, instant access accounts allow you to deposit and withdraw your money whenever you like, without incurring any penalty charges. They do exactly what they say: any request to withdraw funds to your deposit account or to another account is almost instantaneous. However, you should bear in mind that the receiving bank might undertake its own checks before crediting the amount, but this is usually measured in hours rather than days.

It’s an easy-to-use and flexible savings option that generally offers a higher interest rate than a standard current account. The rate of interest paid is usually “variable”, which means it can go up or down depending on changes in the Bank of England’s base rates as well as the bank’s own policy. For this reason, it makes sense to check what rates are on offer from time to time to see if better rates are available with another provider.

It could be useful to have your rainy-day savings parked in this kind of account.

2. Fixed term savings accounts

A fixed-term account typically offers better rates of return than instant-access accounts but come with a catch: you must give up access to the money for the period over which the term runs.

The fixed term can be from between three months and five years, with the level of interest paid increasing to reflect the amount of time you’re happy not to touch the money.

You’ll need to deposit a sum at the beginning, and additional deposits are not allowed after that. Future deposits will have to be placed in new accounts which might be offering different rates of return.

The interest offered is fixed at the start of the period. So if interest rates in general increase after the fixed term has started, there is a risk other accounts could become more attractive. On the other hand, if interest rates start to fall you’ll be better off than other depositors. There are expectations that interest rates will start coming down towards the end of this year – meaning now could be a great time to lock in a good rate.

It doesn’t necessarily follow that the longer the notice period, the higher the interest rate. It is perfectly possible to find a notice account with a 30-day period that offers higher interest rates than one with a 60-day notice period. So shop around and compare rates and terms to find the best fit for your financial goals.

These accounts are ideal if you have a known expense in the future and just want to lock your savings away until then while earning a guaranteed return.

3. Notice savings accounts

A notice or ‘limited access’ account falls somewhere between the two options above. Like a fixed-term account, it typically offers a higher rate of interest than general deposit and instant-access accounts. Similarly, the amount of interest you receive can vary with the amount of time you are prepared to consider leaving your money alone.

But unlike a fixed-term account, notice accounts allow you to withdraw some or all your savings. You usually have to give between 30- and 180-days’ notice if you want to make a withdrawal, and you will typically lose any interest you would have earned during the notice period. Alternatively, you might have to pay a penalty such as losing a small percentage of the initial deposit.

There may be a limit on the number of withdrawals you can make in a year and in extreme cases, repeated requests to withdraw money could lead to the bank or building society closing the account.

So make sure you understand the terms and condition before applying.

Do you pay tax on cash savings?

Potentially, yes.The personal savings allowance (PSA) lets many people earn up to £1,000 in interest on cash and certain investments each year without paying tax on it. Tax-free interest started in April 2016 when the government introduced PSA to encourage people to save more of their money.

The allowance you get depends on what rate of income tax you pay:

• Basic rate (20%) taxpayers can earn £1,000 of interest in the 2024/25 tax year before paying tax
• Higher rate (40%) taxpayers have a lower allowance of £500
• Additional rate (45%) taxpayers don’t receive any PSA
  
  

Above this allowance, interest on your savings is added to all your other income to determine how much tax you must pay. In the 2024/25 tax year, tax rates on income, including savings interest, are as follows:

• The basic rate band is £37,700, which means broadly speaking you pay the 20% basic rate tax on income and interest from the income tax personal allowance of £12,570 up to £50,270
• If your taxable interest falls between £50,271 and £125,139, you would pay the higher rate of 40%
• The additional rate of 45% is payable for savings interest above £125,140

Please note that tax rates on dividends from shares are different, and if you are a Scottish taxpayer the rates and bands are different too.

Read more: Tax on savings explained

Choosing a savings account

It can be difficult researching interest rates and keeping on top of new offers as they become available from banks and building societies.

New offers are rarely coordinated across the financial services industry. They are more likely to be triggered by current savings offers coming to an end, or by a change in a bank’s need to increase deposits or borrow money.

A cash savings platform can help. Offering a range of cash saving accounts with different interest rates from a variety of providers it does some of the hard work for you. Simply sign in, review the rates on offer and switch accounts. However, if you have placed any money on deposit in a fixed term account you won’t be able to switch provider until the term comes to an end.

Find out how Charles Stanley Direct Cash Savings powered by Bondsmith could help you find better returns on your cash.