Every type of savings account explained plus the tax trap to avoid

Saving money is a vital part of life but it can be confusing knowing where to put your money.

Should you lock it away into a fixed term account or put it in an easy access? Is it worth having savings while you’re trying to pay off your mortgage?

MoneyMagpie Founder Jasmine Birtles said: “It’s important to make your savings work hard for you. You need to make sure you’re saving for the long-term as well as have an emergency fund on hand for those unexpected emergency costs.”

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Interest and taxes

If you earn above a certain amount each year in savings interest, you will need to pay tax on the interest. This does not count for any interest earned in an Individual Savings Account (ISA).

If you do not earn above the Personal Allowance through other income, such as work, you don’t pay tax on the interest. You also won’t pay tax on the first £5,000, known at the starting rate for savings, if your total income is below the Personal Allowance (£12,570). The rate tapers off after that, based on your income.

This can be complicated and how you pay the tax depends on your other earnings and if you’re self-employed or pay tax through PAYE. GOV.UK has a useful guide to learn more.

Easy access savings

Easy access savings are savings accounts that you can get your money out of at any time. Make sure to check the details, though, as some will have limits on how many times you can make withdrawals each year.

The interest rate on easy access accounts is typically low, so it should be your first-stop emergency fund money. This is because your cash could be earning more interest elsewhere.

Fixed-term savings

Fixed-term accounts normally have a higher rate of interest than easy access, but require you to lock your money away for a set period of time to get that interest rate.

Some allow up to three withdrawals in a year without a penalty, so check the fine print. Fixed-term accounts are handy for building wealth with compound interest.

But remember, you could end up paying tax on the savings interest earned, which might cancel out any benefit of the higher rate offered.

Regular savings accounts

Many current accounts come with regular saver accounts. These might be easy access or fixed term accounts, so check the fine print.

A regular saver account is designed to encourage people to save smaller amounts each month to get into a savings habit. They have a maximum limit for what you can pay in each month – and if you take money out, you don’t get to top it up again that same month if you already paid in the maximum amount.

For example, if the maximum is £200 a month, and you pay in £200 but then take out £300, you can’t then put £200 back in within the same month.

Regular savings accounts can come with very high interest rates, such as First Direct and its 7% regular saver. There are downsides: you usually only get that interest rate for a year, and there is a maximum amount to pay in each month. If you miss payments, some accounts will run a penalty on the total interest paid, too.

Cash ISA

Everyone gets a maximum Personal Allowance of £20,000 to pay into an ISA account each year. This amount does not roll over to the next year if you haven’t used it up.

This type of account is always tax-free: you never pay tax on the interest or gains within the account. There are different types of ISA, and the £20,000 is the total limit that can be spread across all of them. You can also have more than one of each type.

Cash ISAs can be easy access (with lower interest rates) and fixed term (with penalties for withdrawals). The interest rate also usually drops after the first year’s introductory rate is over, so it is worth setting a reminder to check for new ISA rates when it ends.

Stocks and Shares ISA

Stocks and Shares ISAs allow you to earn tax-free interest on gains made on the stock market for investments within the account. As with any investment, there is a risk to your money that you lose some, so could end up with less than you put in.

They are, however, a long-term product: the longer you can leave your investments, the more time they have to grow and mitigate any market dips.

Innovative Finance ISAs

Innovative Finance ISAs allow you to use some of your Personal Savings Allowance to support peer-to-peer lending for potentially much higher gains.

It is a riskier approach to investing, so it is generally not recommended that you use all of your allowance unless you already have a significant amount of savings in place elsewhere.

Lifetime ISAs

A unique product that allows you to pay in a maximum of £4,000 of your Personal Savings Allowance each year, the Lifetime ISA (LISA) has a dual purpose.

First, it replaced the Help to Buy scheme as a way to save for your first house deposit. Second, people can use it as a tax-free retirement account.

There are significant restrictions to these accounts. You can only open them between the ages of 18-39, pay in a maximum of £4,000 a year, can only pay in until you’re aged 50, and must only access the funds only when buying your first property or once you turn 60 years old.

However, there is one huge bonus: the Government tops up your allowance by 25% of your contributions each year. So, if you pay in the maximum £4,000 a year, that tops up by £1,000 to leave you a total of £5,000.

For someone who pays in the maximum between the ages of 18-50, that’s £32,000 free money from the Government. If you access the funds outside of these rules, you lose the bonus payment AND face a penalty fee.

Savings accounts for children

Children can have regular savings accounts or Junior ISAs set up for them. A Junior ISA has a maximum annual allowance of £9,000 and can be a great tax-efficient way to save for your child’s future.

They can take over control of the account when they turn 16, but not access the funds until they are 18 years old. Many people use it to create a nest egg to help their child launch into adulthood with a house deposit or funds for university.

Help to Save Account

If you claim Universal Credit, even just £1 in any assessment period, you could be eligible for a Help to Save account. This is a Government account that lets you pay in a maximum of £50 a month over four years.

In years two and four, you’re paid a bonus by the Government which is 50% of the highest balance paid in over those two years. For example, if you paid the maximum £50 a month for all four years, you would receive a £600 bonus at the end of year two and another £600 bonus at the end of year four. This is a huge return on your savings.

You can only hold the account once, and can withdraw money if you need it, but can’t top it up again that month if you have already paid in the full £50 allowance.

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