Topic 5: Savings Products

Question 1

Why do people save?

Answer 1

So that they have the funds to pay for goods and services in the future. Savings are therefore ‘delayed spending’.

Question 2

What might future payments be for?

Answer 2

• needs - such as paying a deposit on a rented flat
• wants - items that savers cannot afford on a day to-day basis, such as a computer
• aspirations - goods or services that they would like to have or to experience in the future, such as a holiday

Question 3

Factors to consider when choosing a savings product:

Answer 3

• What is the rate of return (how much interest will I earn?)
• Is the rate of return higher than inflation?
• Will I have to pay tax on the interest my savings earn?
• How often will I be able to withdraw money?
• How regularly will I want to save?
• How will I overeaten the account online, with a passbook, etc.
• How safe will my savings be?

Question 4

Where are savings products available?

Answer 4

Savings products are available from a range of providers such as banks, building societies, credit unions and friendly societies. These providers use the money deposited in savings accounts to lend to borrowers. The difference between the higher interest charged on loans and the lower interest paid on savings contributes to the provider’s income

Question 5

Return on savings:

Answer 5

The return on savings is the interest that the provider pays the account holder and is expressed as an annual equivalent rate (AER), such as 2.2% AER. The AER is the interest that will be earned on the money in one year and takes into account how often the provider pays the interest (for example, monthly or annually), the effect of compounding the interest and any fees and charges. All providers must use the same formula to calculate the AER they quote in advertising so that people can compare the return on different savings products. This formula is set out in the Code of Conduct for the Advertising of Interest Bearing Accounts published jointly by the former British Bankers’ Association and the Building Societies Association

When comparing the return on savings it is important that people compare like with like, for example AERs or gross figures (before income tax). Some provider adverts show a ‘headline’ interest rate using a large font. Potential savers need to explore what this headline rate means before making a decision about which account to use

Providers set the AER on a particular product in relation to the Bank of England’s Bank rate and the savings rates offered by other providers in the market. The Bank of England uses the Bank rate to control the interest rates that providers offer on both savings and loans and so to control the rate of inflation. The Monetary Policy Committee (MPC) of the Bank of England meets regularly to consider whether to change the Bank rate. Bank rate was held at the low level of 0.5% from March 2009 to August 2016, when it was lowered again to 0.25%. After increasing slightly, it was lowered to 0.1% in March 2020 in response to the economic shock caused by Covid-19. In December 2021 it was increased for the first time in three years to 0.25%. In 1991 Bank rate varied between 10.38% and 13.38%

A low Bank rate means that savers receive low returns on their savings. The theory is that this will encourage people to spend rather than to save and so ease the recession

Question 6

Factors affecting the return offered by providers - The amount of money that is saved:

Answer 6

In general, larger sums of money earn higher rates of return. For example, Tom is receiving 0.10% AER on his savings of £500 while Kevin has savings of £1,000 in the same type of account and earns 1.50% AER. Usually, a minimum amount has to be deposited in order to open a savings account, but this can vary from as little as one pound to thousands of pounds

Question 7

Factors affecting the return offered by providers - How often money is saved

Answer 7

People can usually achieve higher rates of return on their savings by saving a specific amount each month. For example, Cho saves £100 a month in a regular saver account that pays 1.35% AER. If he chose to save the money in an account with the same provider that was not designed for regular deposits he would earn only 0.45% AER on his savings

Question 8

Factors affecting the return offered by providers - How long the money is saved

Answer 8

The longer the term that the savings are held, the higher the interest rate tends to be. For example, Claire has a six-month fixed savings bond that pays 1.30% AER while her sister Diane has the two-year version of the product, which pays 2.10% AER.
Their older sister Rebecca has the four-year version of the product, paying 2.40% AER

Question 9

The different categories of savings accounts:

Answer 9

• Instant access accounts - a saver can withdraw money immediately from these at any time with no charge
• Notice accounts - a saver has to give notice, that is, to advise the provider a set amount of time before withdrawing money. Notice accounts usually pay higher AERs than instant access accounts. Failing to give notice usually results in the loss of the interest earned during the notice period - for example, if the notice period is 90 days, a saver who did not give notice would lose 90 days’ worth of interest
• Fixed period accounts or bonds - these products pay a fixed AER for a set period of time, such as six months or two years. The provider may allow only limited withdrawals or no withdrawals during the term. These products usually pay higher AERs than instant access accounts and notice accounts with shorter terms

One advantage of fixed period accounts or bonds is that the fixed rate of return means savers know what the AER will be throughout the life of the product. Products that are instant access or notice accounts usually have variable interest rates that move up and down with changes in the Bank rate. Savers are therefore uncertain about how much interest the provider will pay over the long term

Question 10

Factors affecting the return offered by providers - The number of withdrawals the saver can make:

Answer 10

Savings accounts called ‘instant access’ or ‘easy access’ allow as many withdrawals as the saver wants, whereas some accounts are called ‘restricted access’ and only allow a certain number of withdrawals to be made each year. For example, Will’s savings are earning 0.50% AER in an instant access account while Ted’s savings are earning 2.00% AER from the same provider in a product that allows a maximum of five withdrawals per year

Question 11

Factors affecting the return offered by providers - The account application and operation channels

Answer 11

Accounts that the customer applies for and operates online tend to offer higher rates of return than accounts that are operated by a passbook in a branch, or by cash card, telephone or post. This is because the customer does most of the administrative work themselves when operating a product online (such as typing in their name and address details and transferring funds between accounts). Providers have to pay the costs of running branches and paying staff for customers who want to go into a branch

Question 12

Factors affecting the return offered by providers - The tax status of the account

Answer 12

In the March 2015 Budget, the Conservative-Lib Dem coalition government announced changes to the way that savings interest is taxed. The interest earned on some accounts is tax-free while on other accounts the saver must pay tax on any interest that exceeds their ‘personal savings allowance’

Question 13

Factors affecting the return offered by providers - Introductory bonuses

Answer 13

Some savings accounts have fixed introductory bonuses that boost the return in the first year of the account

Question 14

Impact of inflation:

Answer 14

Inflation - that is, a general rise in the price of goods and services - affects the purchasing power of money because £100 in one year’s time buys less than £100 buys today. Savers need their money to earn an AER that is the same as the rate of inflation to maintain the purchasing power of their money. If the AER is higher than inflation, the real value of their savings will grow because its purchasing power is increasing. People can find out the current rate of inflation at the Bank of England website.mThe Bank of England is tasked with managing inflation to meet the government’s target of 2.0%

Question 15

Two indices are used to measure inflation:

Answer 15

• the Consumer Prices Index (CPI)
• the Retail Prices Index (RPI)

The CPl is used to measure the inflation rate managed and quoted by the Bank of England. Both the CPl and RPI measure inflation by calculating the average change in prices of a basket of goods over a 12-month period. An inflation rate of 1.8%, for example, would mean that overall prices were 1.8% higher than they were 12 months ago

Question 16

The basket of goods:

Answer 16

The basket of goods used as the basis of the CPI or RPI is made up of around 700 consumer goods and services that represent the spending patterns of UK households. Around 180,000 separate price quotations are used every month from 150 areas of the country to compile the indices. The prices are then weighted according to the pattern of UK household spending, so if one good represents 10% of an average household’s spending then it is weighted as 10% of the basket

Goods and services are regularly added to and removed from the basket to reflect current spending preferences - for example, coffee pods and microwavable rice were added in 2016, half-chocolate-coated biscuits were added in 2017, body moisturising lotion was added in 2018, smart speakers were added in 2019, and gluten-free breakfast cereal was added in 2020, while during that time gloss paint, organic apples and sliced turkey were removed

The main difference between CPl and RPI is that RPI includes mortgage interest payments and other owner-occupier costs, while CPI does not

Question 17

Affect of inflation:

Answer 17

Inflation caused prices to increase considerably over the 53 years between 1955 and 2008. Since 2008 prices have continued to increase. For example, private rents averaged £153 per week in 2008-2009, compared with £201 per week in 2019-20. The average annual domestic electricity bill rose from £539 in 2010 to £696 in 2020

Question 18

Taxation:

Answer 18

Since April 2016, providers pay all interest on savings accounts gross (before tax) and savers pay any income tax they owe. Savers have a ‘personal savings allowance’ for the amount of savings interest they receive before any income tax is charged. This allowance is £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers. Additional-rate taxpayers do not receive a personal savings allowance

In addition, savers who earn less than the personal allowance for income tax can use it to earn more interest tax-free. They benefit from a ‘starting-rate band’ of £5,000 above the personal allowance. For example, Heather was made redundant last year.
Since then she has had a job that is only part-time. She earns below the personal allowance threshold and so does not pay income tax. Heather has money in a savings account that she saved before being made redundant. The interest that she earns on these savings is tax-free, unless she earns enough interest to exceed the personal allowance and the starting-rate band, which is very unlikely.

Question 19

Individual savings accounts (ISAs)

Answer 19

The interest on individual savings accounts (ISAs) is paid free of tax. The government introduced ISAs in 1999 to encourage people to save. They are popular with savers, whether or not they pay tax, because the AERs tend to be very competitive. In 2014 a new ISA limit was introduced, and restrictions were removed on how much money could be saved in stocks and shares

The money in an individual savings account (ISA) can be invested in cash and/or stocks and shares. Cash ISAs are available for savers from the age of 16, and stocks and shares ISAs are available for savers from the age of 18. The interest on a cash ISA is paid free of income tax and does not count towards the saver’s personal savings allowance. The return on a stocks and shares ISA is paid free of income tax where the return is in the form of interest (where the return is paid in the form of dividends, income tax is payable). Any growth in the value of the capital invested in a stocks and shares ISA is not subject to capital gains tax

During the annual Budget speech, the Chancellor of the Exchequer sets the maximum amount that can be deposited into an ISA in any one tax year. This amount can be split in any proportion between cash and stocks and shares. Savers are only allowed to contribute to one cash ISA and/or stocks and shares ISA in a tax year

There are different cash ISA products that offer instant access or fixed terms. For example, Jenny opens an instant access cash ISA on 6 April. She deposits money into the ISA whenever she can and reaches the maximum amount that can be paid in. In the March 2015 Budget, the Conservative-Lib Dem government reformed the cash ISA rules so that savers can withdraw money and replace it if the provider offers a flexible ISA (GOV.UK, 2015). This means that Jenny can take money out of her ISA and put it back in later, up to the maximum amount, without the money losing its tax-free status

Savers can transfer funds from a cash ISA into another cash ISA or into a stocks and shares ISA during a tax year. They can also transfer funds from one stocks and shares ISA to another stocks and shares ISA, and from a stocks and shares ISA to a cash ISA. However, such transfers depend on the terms of both the original ISA and the new one - some ISAs do not allow funds to be transferred in, for example

Question 20

Transferring funds between ISAs

Answer 20

Reuben has an instant access cash ISA with a bank that pays 0.5% AER. He paid in £2,000 during the tax year. Reuben wants to transfer all his savings from this cash ISA to a cash ISA at a building society that pays 2.10% AER. The building society will accept transfers into its cash ISA from other cash ISAs and there are no penalties from the bank for transferring out of its product

Reuben was planning to move his funds by withdrawing the money in cash from the bank ISA at his local branch, and paying it into his new ISA
at the building society branch across the street. At the bank counter, the assistant explains to him that he needs to complete a form for the building society, which will then make the transfer for him. Transfers cannot be made by withdrawing the cash from one ISA and paying it into another because of the rules on how many ISAs a saver can contribute to in one tax year and the deposit limits. There are no limits on the number of ISAs a saver can hold over time, just on the number that they can pay into during any one year

Question 21

Junior ISAs:

Answer 21

As well as the adult ISA described above, there is a Junior ISA designed for savers under 18, with its own specified deposit limit. The Junior ISA also pays interest free of tax and offers cash and/or stocks and shares options. The Junior ISA replaces the Child Trust Fund (CTF) account, so is only available to young savers who do not have a CTF. From 6 April 2015, savers with a CTF are able to transfer the funds to a Junior ISA if they wish. Parents and guardians with parental responsibility can open a Junior ISA for savers who are under 16 years old; people aged 16 or 17 can open their own Junior ISA.
Anyone can pay money into a Junior ISA as long as they do not exceed the deposit limit for the tax year - so, for example, parents and grandparents can pay into the Junior ISA to save on the child’s behalf. However, only the child named on the Junior ISA can withdraw money from the account, and they cannot do this until they are 18 years old

Question 22

Help to Buy ISAs:

Answer 22

Help to Buy ISAs were available from 1 December 2015 from a range of banks and building societies

• First-time buyers can save up to £200 a month towards their first home in a Help to Buy ISA and the government will boost their savings by 25% when the account is closed. That is a £50 bonus for every £200 saved and all interest earned is tax free
• First-time buyers who save £12,000 in their Help to Buy ISA will be eligible for the maximum government bonus of £3,000
• As the accounts are for individuals, couples can save separately and both receive the government bonus

The Help to Buy ISA was available for new savers until 30 November 2019. It was replaced by the Lifetime ISA, available since April 2017. People with a Help to Buy ISA can transfer their savings into a Lifetime ISA if they wish

Question 23

Lifetime ISAs:

Answer 23

Anyone aged over 18 and under 40 can open a Lifetime ISA to help them buy their first home or to save for their retirement. However, most providers do not offer Lifetime ISAs

Up to £4,000 can be saved into this ISA every year until the saver reaches the age of 50. The government will add a bonus of 25% of the saver’s contributions at the end of every tax year. This means that savers who add £4,000 in one tax year will receive a bonus of £1,000

Savers can withdraw money from their Lifetime ISA when they buy their first home or when they reach 60 and keep the government bonus. Savers who withdraw the money before age 60 and who are not buying a first home will pay a 25% withdrawal charge on the total, losing the government bonus.
Lifetime ISA contributions count towards the saver’s ISA limit for the tax year

Question 24

Safety:

Answer 24

One of the reasons that people save is to have funds to call on in emergencies and in old age. Safety - that is, the likelihood that the money saved will be available when needed in the future - is therefore an important factor when people decide where to save money. Most people place money in products they consider reasonably safe before considering deposits in more risky products

Question 25

Financial Services Compensation Scheme (FSCS)

Answer 25

The Financial Services Compensation Scheme (FSCS) guarantees up to £85,000 of savings in UK banks, building societies or credit unions that are authorised by the UK financial services regulator, the Financial Conduct Authority (FCA). This means that if the provider is in default - that is, it is unable to pay account holders their savings - the FSCS will pay 100% of what is owed up to £85,000 per person per provider. According to the FSCS, 98% of the UK population has less than £85,000 in savings and would therefore be covered for all of their savings under the compensation scheme (FSCS, no date).
In some cases, a number of banks and building societies belong to a single financial services group. This means that they share authorisation with the regulator and so are counted as one provider. For example, the Bank of Scotland plc authorisation covers the Bank of Scotland, Birmingham Midshires, Capital Bank, Halifax and Intelligent Finance. All five banks count as one provider, so if a saver had £50,000 in an account provided by Halifax and £50,000 in a Birmingham Midshires account, only the first £85,000 of their savings would be protected. Savers can check how their provider is authorised on the FCA’s website. The FSCS is an independent body set up under the Financial Services and Markets
Act 2000 (FSMA) and makes no charge to savers for using its service

Question 26

National Savings and Investments (NS&I)

Answer 26

People who want 100% of their savings guaranteed, regardless of the amount, can Save with National Savings and Investments (NS&I) which is backed by Her Majesty’s Treasury. This provider offers a range of savings products including cash ISAs, instant access savings accounts, and longer-term savings

Question 27

Cash versus stocks and shares:

Answer 27

This topic focuses on cash savings products rather than investments linked to stocks and shares. These types of investment are much more risky than cash as they gain or lose value according to movements in the stock market, which can be unpredictable

Question 28

Choosing savings products:

Answer 28

There are product features that people need to consider when choosing a savings product. To choose the most appropriate savings product, people need to consider how these features match their personal circumstances, such as their need to pay bills and have funds for emergencies, and the timing of their wants and aspirations

Question 29

features to consider when choosing a savings product

Answer 29