Maximising your savings in a low interest rate environment
The historically low interest rate of 0.5 per cent has been a huge boon for homeowners in the last twelve months. But for savers trying to get a decent return on the money they have stowed away it has been a nightmare. Kate Saines looks at the options for savers who are trying to build a nest egg.
This month marked an important financial milestone as the Bank of England announced interest rates would remain at their historic 0.5 per cent low for the eleventh month in a row.
This of course is good news if you have a variable rate mortgage. But it's bad news if you are a saver.
Thanks to the consistently low base rate coupled with inflation rises there are now few variable rate savings accounts on the market with decent rates.
If you want an interest rate which pays substantial returns your only solution is a long term fixed-rate bond, which can pay rates of up to five per cent.
Analysis by independent financial research company, Defaqto, reveals instant access savings accounts currently offer an average - and very pitiful - interest rate of 0.86 per cent for customers with a balance of £1,000.
The highest possible rate on offer is a very exceptional three per cent.
Fixed-rate products, meanwhile, are offering an average rate of 2.7 per cent for the shortest-term one-year account, according to Defaqto.
A five-year fixed-rate savings plan offers an average of 4.43 per cent to a saver with a £5,000 balance and the highest interest on offer for one of these deals is 5.1 per cent.
The problem is fixing does not suit everyone. The major downfall of these fixed-rate deals is that you cannot usually access your cash until the term has expired.
If you are using your savings account to earn an income or to provide for unexpected costs - a broken boiler or major dental work, for example - you will naturally want an account from which you can make penalty-free withdrawals.
So what are savers to do in 2010?
Thankfully, there are ways you can make the most of the savings products available without compromising all your flexibility or income.
Defaqto suggests one method is to use accounts with bonus rates.
David Black, the firm's banking specialist, says: "Those wishing to get the best variable savings rates really need to move their money around on a regular basis to take advantage of any special deals such as introductory bonuses.
"Some existing accounts pay rates as low as 0.01 per cent, so savers really need to avoid the obvious pitfalls of inertia."
Bonus-rate accounts work by offering a higher rate of interest for a limited period - usually a year.
If you can be bothered to switch after the introductory period to another bonus rate account, you will certainly be assured of some of the best variable rates.
However, you must be cautious when opening these accounts. Analysis by comparison website Moneysupermarket.com has shown that when the introductory bonus ends, the rate usually plummets to half the size.
It warns that if you forget to switch you could end up losing on average £86 of interest. So, it's important to keep a note in your diary of when the bonus rate is due to expire.
Putting as much of your annual savings into an ISA as possible will help you maximise your savings as you will not be taxed on interest earned.
From April 6th everyone's ISA allowance is to go up and as a result you can now store up to £5,100 in a cash ISA and £10,200 in a stocks and shares version.
As with savings products, fixed-rate ISAs are currently offering the best interest rates. According to Defaqto, the average easy access cash ISA is offering a rate of 1.37 per cent for a customer with the current maximum subscription of £3,600.
But fixed-rate ISAs are paying an average gross AER or 3.38 per cent.
ISAs are not the only way of earning tax-free interest, National Savings and Investments (NS&I) offer a variety of ways to tuck your cash away without having to hand anything to the tax man. What's more, your savings are government-backed and therefore secure.
NS&I, for example, are the providers of Premium Bonds which have the major advantage of paying out tax free prizes every month to bond-holders.
While they do not pay interest, the chances of winning have improved recently.
The statistics show that a person with the maximum amount of £30,000 invested into Premium Bonds, and with average luck, could win 15 prizes a year.
There are 1,635,393 prizes of £25 paid out each month and one £1 million jackpot. But you could also be one of almost 30,000 people who could win £100 or 17 who will win £25,000. And there are many other cash sums available.
NS&I will also return the money you invested at any time. So although you won't have earned interest, if you ever need to access cash urgently you can retrieve your savings.
Defaqto recommends NS&I's Index Linked Certificates as a way of beating the effects inflation has had on savings. Not only are these tax-free but they pay 1 per cent above inflation, as measured by the Retail Price Index (RPI).
They are, unfortunately, available only over three and five-year periods. However, the good news is that NS&I will allow you to cash them in early. If you decide to cash them in after a year, you will still be paid any index-linking or interest earned.
NS&I also offers Fixed Interest Saving Certificates in its tax-free range. Although these two and five-year products' rates are not as high as some other fixed-rate accounts on the market, they do allow penalty-free withdrawals after a year. And they have tax-free status to boot.
You don't just have to look to accounts with the word 'savings' in the title to earn interest on any nest egg you might own.
David Black of Defaqto explains: "Savers have to be incredibly proactive to get the best deals and, apart from some cash ISAs, the only bank and building society savings account that give the higher rate taxpayer any chance of a real rate of return are a handful of regular savings and current accounts, as well as a few fixed-rate bonds."
Believe it or not there are several current accounts on the market which pay interest of as much as 2.5 per cent if sufficient funds are paid into the account.
Some even pay as much as six per cent- although there is usually a maximum balance limit of around £2,500 which cannot be exceeded for the interest to be paid.
Although this is not necessarily good news for savers with huge deposits, it's certainly handy for those with modest savings who need easy access.
But you can also earn yourself money simply by opening a current account.
Alliance & Leicester, for example, earlier this year offered £100 to new customers opening its Premier Current Account. It also offers an in-credit interest rate of 0.5 per cent - as much, and in some cases more, than some easy access savings accounts.
In order to receive the bonus you are required to switch all your direct debits and standing orders to this account. However, if you have the organisational skills to use this as both your current account and savings you could earn yourself £100 plus interest until better deals on savings accounts emerge.
And then there are reward current accounts. Bank of Scotland has a product which pays £6.25 per month to customers whose accounts are funded by £1,000.
The downfall of using most of these accounts as a savings vehicle is that you need to have quite high amounts of cash in your account each month to receive interest or rewards.
It is also important to check the small print, such as the overdraft interest rate, for example. As you could end up paying out more than you receive if you are not careful with your cash.
And Mr Black warns these products are few and far between. "The total number of such accounts barely reaches double figures and many of them have conditional additional requirements," he adds.
His message about being proactive, however, appears to be the key to maximising your savings potential.
By putting in the research, scouring the market, being organised and also being willing to switch products you can certainly beat the negative effects of the Bank of England's low interest rate.
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