Introduction to cash

Having cash savings readily available can provide us with more choices and freedom in life, as well as financial security. Here’s how to get the most from yours.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. Tax rules can change and their effects on you will depend on your individual circumstances

What you’ll learn:

  • What impact interest rates have on your savings.
  • How inflation eats into your savings.
  • How your returns are taxed.

Modern living can sometimes feel like a never-ending conveyor belt of expenses, but while getting into the habit of regular saving might not be easy, it’s well worth doing.

Even putting away a little every month can make a big difference in the long run, and it makes sound financial sense to have a cash buffer in place to last you a few months should something occur to interrupt your income stream.

Living without interest

Unfortunately for savers, the backdrop over recent years has been challenging to say the least.

Back in March 2009, in a bid to prop up the UK economy during the financial crisis, the Bank of England’s Monetary Policy Committee (MPC) cut the base rate to just 0.5%, then again to 0.25% in 2016. It raised the base rate for the first time in ten years from 0.25% to 0.5% in November 2017, and again from 0.5% to 0.75% in August 2018.

While low interest rates have been great news for borrowers, they’ve been anything but for savers. Until interest rates begin to start rising once again, achieving the best possible interest rate these days requires savers to put some legwork in to find the best deals. The job isn’t over once you've found an account either. You’ll need to watch that the rate doesn't drop, and be prepared to switch to ensure your savings aren't getting lower returns than they could achieve elsewhere.

The power of compound interest

One of the big benefits of saving regularly is the impact of compound interest.

This can help your cash to grow more rapidly because you’re not only enjoying interest on the money you’ve saved, but you’re also earning interest on this interest.

For example if you put a £10,000 lump sum into a savings account paying 1% per annum, by the end of year one you’d have £10,100, and so in year two you’d be earning interest on an even higher amount, and the sum will rise further as the years go by.

Remember there are a variety of savings account types to look at, which could help you get into the savings habit. Regular savings accounts, for example, can be a good starting point, as with these accounts you need to generally pay in a set amount every month usually for a year to earn the interest on offer.

Risks to your savings

Inflation has often been called the ‘silent assassin of savings’. After all, inflation marks an increase in the cost of everyday items. The higher it rises the more it devalues your cash and therefore, its spending power. If you’re shopping around for a decent savings account always try to find an account that if possible at least matches and ideally exceeds, the current rate of inflation.

Taxing returns and allowances

If the interest rate you find does exceed the rate of inflation, then all that hard work you've done finding that good rate can be undermined by income tax, which can reduce the total return savers receive. However, as a result of the Personal Savings Allowance (PSA), which came into effect on 6 April 2016:

  • Basic rate taxpayers (20%) can earn up to £1,000 in interest tax-free.
  • Higher rate taxpayers (40%) can earn up to £500 in interest tax-free.
  • Additional rate taxpayers are not entitled to any Personal Savings Allowance.

Find out more about the Personal Savings Allowance (PSA)

The PSA means that for the majority, income from their savings will be tax free, so their main challenge will be simply hunting down an account paying the highest interest rate.

Cash ISAs

Don’t forget Individual Savings Accounts (ISAs), which have a maximum contribution allowance of £20,000 in the 2019-20 tax year. The benefit of saving in an ISA is there’s no tax to pay on any interest earned for basic, higher or additional rate taxpayers.

Cash ISAs may now appear less attractive following the introduction of the PSA as the majority of people no longer have to pay tax on income derived from savings. However, if interest rates start to rise, you’ll need to save much less to reach the £1,000 or £500 thresholds, unless of course the PSA limits rise too, although there’s no guarantee that this will happen.

Remember that any interest or income you earn from either cash, investment, innovative finance, or lifetime ISAs doesn’t count towards your PSA, so ISAs are still well worth considering as part of your overall long term savings and investment strategy, especially if you’re in the additional-rate tax bracket and/or a big saver.

Bear in mind that tax rules might change in future and that their effects on you will depend on your individual circumstances.

Protection matters

Cash deposits made with financial institutions authorised by the Prudential Regulation Authority1 (PRA) are covered by the Financial Services Compensation Scheme (FSCS) which has a maximum compensation limit of £85,000.

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