Six Snags With Savings Accounts

When choosing a safe home for your spare cash, make sure that you read the small print. Otherwise, you might fall into one of these traps!

Here in the UK, saving money has become deeply unfashionable. Indeed, the savings ratio (the proportion of our take-home pay which we save) has collapsed during the housing boom.

In 1992, the savings ratio was an impressive 11.7%. Thus, sixteen years ago, we saved over a ninth of our take-home pay. In the first quarter of 2007, this ratio had fallen to a pathetic 2.4%, its lowest level since 1959. However, as the housing boom ground to a halt, the savings ratio started to climb again, reaching 3.4% by September 2007.

Thanks to the worldwide credit crunch, worries about a weakening economy and house prices, and the Northern Rock fiasco, I expect the savings ratio to continue to climb. I predict that 2008 will be a good year for British savers.

So, what should you look for when choosing a savings account? Of course, your first aim should be to find a table-topping rate of interest. My advice is to use the Bank of England's base rate as a guideline. The base rate currently stands at 5.25% a year, so ignore all accounts paying rates below this.

The second thing you must do is to inspect an account's terms and conditions. In other words, you need to scan the small print to find the nasties lurking within. Otherwise, you risk falling into one of these six traps:

1.The bait and switch trick

This is one of the oldest tricks in the savings book. It works like this: a bank, building society or other savings provider launches a savings account which pays a tasty interest rate. Ideally, the account should appear in the Best Buy tables produced by Fool partner Moneyfacts. A wave of `hot money' pours in, with billions of pounds filling up the coffers.

Once the bank has hit its targets, it stops advertising this account and closes it to new savers. After a while, it begins to trim that once-attractive savings rate down to size. Thus, what started out as a first-class account slowly becomes second-rate over time. Alas, thanks to a feeble Banking Code, this is entirely legal, because banks aren't required to notify savers of every rate change. So, don't be lazy -- keep a close eye on your savings rate by checking it, say, monthly or quarterly.

2. Short-term introductory bonuses

Many of the highest-paying savings accounts rely on short-term introductory bonuses to create headline-grabbing rates. Typically, these accounts enhance your savings rate for six to twelve months, perhaps by 1%+ a year. However, after this initial boost ends, the interest rate reverts to the bog-standard rate and the account becomes less attractive.

Thus, you should understand that introductory bonuses give a savings account a leg-up into the Best Buy tables, but they don't last. So, if you do plump for an account which includes a short-term bonus, be sure to move your money when this boost expires. Otherwise, your savings will fall behind the curve.

3. Penalties for making a withdrawal

In recent years, a particularly annoying breed of savings account has emerged. These accounts pay high rates of interest, but penalise you for making even a single withdrawal. Typically, if you make a withdrawal in a month, then you lose all interest payable on your entire balance for that month. In other words, a withdrawal of just £1 would cost you a twelfth of your total interest for that year.

Not for me, thank you!

4. The taxman wants his cut

If you're a non-taxpayer, then you can avoid paying tax on your savings interest by completing a form R85 and giving it to your bank or building society. Otherwise, basic-rate taxpayers lose a fifth (20%) of their before-tax interest to HM Revenue & Customs (HMRC). For higher-rate taxpayers, the tax is doubled to two-fifths (40%) of their interest.

If you don't fancy the idea of paying tax on your savings interest, then your best bet is to open a tax-free savings account known as a cash ISA (Individual Savings Account). In the current tax year (2007/08), you can deposit up to £3,000 into a cash ISA. From 6 April, this rises to £3,600 per tax year.

5. No withdrawals from regular-savings accounts

If you enjoy the discipline of saving the same amount each month, then a regular-savings account should be right up your street. By saving a set monthly amount, say £10 to £500, you can earn a fixed rate of 7%+ a year before tax. Nice!

However, almost all regular-savings accounts require you to make twelve consecutive monthly deposits. In addition, you cannot withdraw any money until the account ends. Thus, it pays to think of regular-savings accounts as one-year bonds which pay a fixed rate on maturity. Of course, when your twelve months are up, you should switch your pot to another Best Buy account. Otherwise, it'll end up earning an inferior rate of interest.

6. Government protection is limited

If your bank goes bust, The Financial Services Compensation Scheme (FSCS) will compensate you for the first £35,000 in your account. However, there is no safety net for any excess above this upper limit. Thus, if you have more than £35,000 in cash, then consider spreading it between accounts in order to reduce the (admittedly small) risk of bank failure.

That's it from me: here's wishing you sweet success as a saver!

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