Mastering Your Money: A Simple Guide to Understanding Savings Terms in the UK

Want to start saving but don’t know where to start? or where to put your money? No worries! In this guide, we’ll walk you through the top savings options, like the Lifetime ISA, and clear up all that confusing financial jargon.

 

What Is A Savings Account

A savings account is a secure place to put your money and earn interest.

 

What is an ISA (Individual Savings Account)?

An ISA (pronounced “eye-suh”) is a tax-efficient savings or investment account available in the UK. You don’t pay tax on the interest, dividends, or capital gains from money within an ISA, making it a popular choice for savers and investors. The amount you can save/invest each year is capped which is currently £20k for the 24/25 tax year. Types of ISAs:

• Cash ISA: Interest you earn on your cash savings is tax-free. Essentially a tax-free savings account.

• Stocks and Shares ISA: Allows you to invest in equities, stocks, shares, bonds, and funds without paying tax on any gains or dividends earned.

• Lifetime ISA (LISA): Designed to help people in the UK save for their first home or retirement.

• Innovative Finance ISA: Earn tax-free interest on investments by lending your money to people or businesses through online platforms (peer-to-peer lending platforms).

 

What is a Lifetime ISA (LISA)?

If you’re aged between 18 and 39, you can contribute up to £4,000 per year, and the government adds a 25% bonus to your savings, up to a maximum of £1,000 per year. The funds can be withdrawn without penalty to buy your first home or after you turn 60 for retirement.

 

What Is Variable Rates and Fixed Rates?

When it comes to savings accounts and even some types of ISAs e.g. Lifetime ISA, you’ll often have to choose between variable and fixed rates. Variable and fixed rates refer to how the interest you earn on your money is calculated:

• Variable Rate: The interest rate on your savings can change over time, based on decisions by the Bank of England or your bank’s discretion. This means the amount of interest you earn could increase or decrease.

• Fixed Rate: The interest rate stays the same for a set period. However, this also means you might not benefit if interest rates rise.

 

What Are APRs and AERs?

APRs and AERs show you how much a financial product (savings account, loans, credit cards, and investments) costs or earns each year.

• APR (Annual Percentage Rate): Commonly used to describe the interest rate on loans or credit cards, it includes both the interest and any additional fees.

• AER (Annual Equivalent Rate): This shows how much interest you’ll earn on savings over a year, assuming you don’t withdraw any funds. It’s a handy way to compare different savings products.

 

What are notice periods?

Some accounts will have notice periods within their terms. This mean you will have to let the savings provider know in advance if you are taking out your money. This is fine if you’re saving for something longer term or where you know when you will need your money. But less useful for emergency savings where you may need to get your money out on short notice. Some will allow you to take out your money with no notice but there may be fees involved or you may lose any interest earned.

 

Fixed term vs Easy Access

A fixed term account normally locks your money away for a set period of time, usually for better rates, whilst an easy access account will allow you access to your money instantly. Again fixed term accounts can be better for longer term targets where when you need the money is well defined or known. Easy access normally best if you want to have instant access to any money saved.

 

What Is Compound Interest?

Compound interest is when you earn interest on both the money you’ve saved and the interest you’ve already earned on that money. Over time, compounding can significantly boost your savings, especially if you’re looking at long-term saving strategies.

 

What Is Drip-feeding: A Strategy for Savers

Drip-feeding involves regularly transferring money from a current account into a savings account or ISA, e.g. Lifetime ISA. This can be particularly effective with high-interest current accounts or when you’re trying to build up your savings gradually.

 

Make It Simple

Bottom line - navigating the jargon of savings can be a simple task. With a clearer understanding of these key terms and concepts, like the Lifetime ISA, you're better equipped to make informed decisions about where and how to save your money, paving the way to a more secure financial future.

 

Savings Terms FAQ’s

How Do I Open an ISA?

Setting up an ISA is quite straightforward. First, choose the right ISA for your needs, e.g. Lifetime ISA, then check eligibility. You’ll then need to research providers (look at interest rates, investment options, fees, and terms). Once you’ve found a provider, apply for an ISA (either online or in-person), transfer your funds into the ISA and lastly manage your ISA, by Keeping an eye on your account. monitor its performance, and make any necessary adjustments.

What Is a Peer-To-Peer Lending Platform?

Also known as “social lending” or “crowd lending” is a way to let people borrow and lend money directly to each other using online platforms, without going through banks. Lenders earn interest on their loans, while borrowers may get better rates than through traditional banks.

Is Fixed or Variable Interest Better?

The answer depends on your goals and preferences. Choose a fixed rate if you prefer stability and want to lock in a set rate for a specific period. Choose a variable rate if you’re willing to take a bit of risk for the chance of higher earnings if rates increase.

Can I Earn More if I Invest Instead of Save?

Many people invest parts of their savings, as it can offer better returns than standard traditional savings accounts. This can include traditional investments such as stocks and funds or less conventional investments such as artwork and vintage wine!

However, it’s important to note that investing does come with a risk. The value of your investments can go up or down. If you choose to invest, it’s normally best to do so for longer term targets. The longer you invest, the better you can handle any ups and downs in the market.

How Does AER Benefit Me In a Savings Account?

AER helps you understand how much interest you’ll earn on your savings over a year, including the effects of compounding interest.

Are APR and AER the same as interest rates?

No, APR and AER are measures that include interest rates but also factor in other elements. Interest rates are the basic rate at which you earn or pay interest. It's a straightforward percentage applied to your savings or loan. While, APR includes fees and gives the overall cost of borrowing, and AER shows the annual return on savings, accounting for how often interest is compounded.