Guide to cash savings

The difference between current and savings accounts

Most of us need to have more than one account to manage our money effectively. By separating our finances into the money we need right now and the funds we need later on, we can earn interest and see our funds grow.

But what is the difference between a current and a savings account?

Current accounts are generally for day-to-day banking. You can have your wage or salary paid in to it, set up Direct Debits and often organise an overdraft facility. They don’t usually have high interest rates so your money won’t earn very much.

With a savings account, you can leave your money in there to allow it to grow through interest. Depending on the account you choose, there may be restrictions on how much you can put in and withdraw, which is why it pays to shop around for the one that suits you best.

How does interest work?

When you have a savings account, the bank or building society borrows the money and pays you interest in return. It’s added to your account to grow the pot of money.

The banks compete for your money by offering different interest rates, but the various types of savings accounts usually have similar rates. For example, regular savings accounts tend to have higher rates because you have to pay in a certain amount each month, guaranteeing the amount they can borrow. Fixed-term deposit accounts have fixed rates that also tend to be higher than others because you have to keep your money in there for a set period of time – usually months or years. Index-linked accounts work in a similar way, but the interest rate can fluctuate. If interest rates are likely to rise, they can bring you bigger returns, but there is more risk.

When you’re choosing the account, it’s worth finding out how and when the interest is calculated and paid. The quicker the interest is paid, i.e. every month, the more money you can earn through compound interest. It’s because there is more money in the pot to earn interest on.

Tax on savings accounts

Most people have a personal savings allowance that allows them to earn interest on ordinary savings tax-free. Basic-rate taxpayers can earn £1,000 of interest per year before paying tax, while higher-rate taxpayers have a £500 allowance. Additional rate taxpayers have no personal savings allowance.

You can earn interest completely tax-free in a cash ISA, though there are limits on how much you can save each year. The total amount you can save annually into all your ISAs is currently £20,000.

Accessing your cash

Although current accounts are recommended for money that you need to use on a regular basis, some savings accounts allow you to access your money and earn interest at the same time. Instant Access accounts, for example, allow you to spend the money when you need it. The interest rate is generally lower than on other savings accounts but still higher than a current account. You may want another savings account as well as this one if you are looking to really grow your pot of cash.

Different accounts for different goals

There are specific accounts for different life goals, like buying a house, having children and retirement. The most commonly used ones are Lifetime, Help to Buy and Junior ISAs. These are designed to make your money grow even faster with bonuses from the government and/or higher tax-free allowances. Not everyone qualifies for the various accounts and it’s a good idea to get advice from a financial adviser about whether these are the best option for achieving your savings targets.

Premium Bonds

Although not technically cash savings, Premium Bonds are often used in the same way because they carry the same amount of risk. These are investment opportunities provided by National Savings and Investments (NS&I). Rather than earning regular interest, your money is entered into a prize draw. If you win, you receive tax-free cash. Like cash savings, your money is secure and you can get it back at any time. There are no guarantees that your money will earn anything, and you might prefer to put your money in a more certain investment if you have specific savings goals to reach.

If you want to explore more options for making your money grow, take a look at our guide to investing.