The recent unexpected fall in inflation means interest rates may have peaked. Savers need to act quickly to find the best savings accounts before they disappear. If you were hoping to secure a rate of 6% or more, you are too late. Accounts offering these rates have disappeared as banks and building societies anticipate that the Bank of England will stick to a rate of 5.25% for the coming months.
Interest rates have rocketed over the past year. Last September the best you could find on an instant-access account was 2.1%, but 14 months later you could secure 5.2%. If you haven’t moved your money, you should. On a £10,000 balance that is a difference of £310, assuming your money was in the best account last autumn. The best instant-access account is currently offered by Metro Bank, paying 5.22%, including a 3.46% 12-month bonus.
However, with interest rates stabilising you should also consider staircasing your savings to enjoy the best possible returns. This is where “you put your money in different length fixed-rate bonds”, says George Nixon in The Times. You have access to some of your cash in instant accounts, some in medium-term accounts and some in long-term bonds. That way you can lock in all the best rates available.
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Traditionally, the longer you lock away your cash the better the rate. At present, however, the best rates are on the shorter fixed-rate accounts. The top-paying five-year bond is JN Bank’s Fixed Term account, now paying 5%. However, you could get 5.8% (which has already fallen from a short-lived peak of 5.91%) on Metro Bank’s one-year fixed-term savings account. “This is because rates are expected to be lower in five years than they are now,” says Nixon.
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In this environment, you should still staircase. If interest rates keep declining, “those who are confident that they won’t need their cash would be better off fixing for longer”, Mark Hicks from Hargreaves Lansdown told Nixon. However, if you are looking for a medium-term account, avoid NS&I’s latest offering. It has relaunched its popular three-year green savings bond but has slashed the rate from 5.7% to 3.95%.
This “has about as much appeal as a winter crossing of the Bay of Biscay on a Saga cruise ship”, says Jeff Prestridge in the Mail on Sunday. In contrast, Al Rayan’s three-year bond pays 5.1% (cut from 5.6%). Al Rayan is a Sharia bank which means it invests its deposits according to Muslim laws. This means it can’t invest in tobacco, gambling, arms, alcohol or pornography. So its accounts can be considered ethical, if not environmentally friendly.
Sharia accounts always have an “expected profit rate” rather than an interest rate, as Sharia principles mean “payment or receipt of interest is not permitted”, Ravi Kumar from Gatehouse Bank told The Telegraph. So, to produce a profit the bank invests in Sharia-compliant funds and then shares this with the customer. You would then receive your deposit plus the profit at the original expected profit rate to that date. Al Rayan is also covered by the Financial Services Compensation Scheme (FSCS), so if the bank went bust you would get up to £85,000 of your savings back.
Watch out for tax on your savings
While you are rearranging your savings, give some thought to your tax bill. Rising interest rates mean many people are at risk of breaching their Personal Savings Allowance (PSA) for the first time since they were introduced in 2016.
The PSA dictates how much interest you can earn on savings before you pay income tax. A basic-rate taxpayer can earn £1,000 a year and higher-rate payers £500. Additional rate taxpayers get no PSA. So £20,000 earning 5% interest would breach the PSA and incur a tax bill for a basic-rate taxpayer. The sum falls to £10,000 for a higher-rate taxpayer.
If you fear exceeding your PSA, put some money into a cash ISA, where it can grow tax-free. The best cash ISA rate is 5.71% on Metro Bank's one-year fix (must be opened in branch) or 5.65% on Virgin Money’s one-year account (only if you have a current account with Virgin, Yorkshire or Clydesdale). Alternatively, you can get 5.11% on Metro Bank’s instant-access ISA, although this includes a 3.46%, 12-month bonus. Aldermore is paying 5.3% on its one-year ISA.
This article was first published in MoneyWeek's magazine and information and rates were correct at the time of writing. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
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