Types of Savings Accounts & How to Choose One

The interest rate on a savings account is typically higher than the ones offered by other types of bank accounts. Depending on the type of savings account the consumer opts for, the interest rate can be variable or fixed, but it’s usually compounded.

Additionally, like everything else in finance, the interest rate amount is influenced by the current state of the economy and market conditions. Still, consumers can also have an effect on their interest rates.

Namely, consumers that deposit larger amounts and lock them away for more extended periods get the highest interest rates.

Given that savings accounts are not meant to be used for everyday transactions, they usually come with some restrictions or limitations on how often withdrawals can be made and how much of the funds can be withdrawn.

Depending on the type of the account and its restrictions, accounts with easier access to withdrawals generally have lower interest rates.

In terms of the number of withdrawals or amount of money withdrawn, going beyond the monthly or yearly limits can result in fees.

In extreme cases, where consumers go beyond the limit frequently, the financial institution can close their savings account and transfer the money to a checking account, where they will bear no interest.

Besides the high withdrawal fees, savings accounts generally have fewer fees than other bank accounts.

Some savings accounts also have minimum balance requirements that consumers must meet to keep receiving interest. Sometimes, they might even get charged a minimum balance fee if they don’t meet the criteria.

The size of the balance that the consumers must maintain to meet the requirements heavily depends on the type of savings account. Naturally, savings accounts with higher interest rates have more demanding requirements and vice versa.

Instant access savings accounts are savings accounts that allow consumers to earn interest on their savings while placing no limitations on access to their funds. Instant access savings accounts are popular with traditional UK banks and online-only banks.

They have no withdrawal restrictions and no minimum balance requirements. They allow consumers to deposit as much or as little as they want and give them unlimited withdrawals without fees or penalties.

On the flip side, they bear the lowest interest rates out of all types of savings accounts and, as such, are typically used for short-term saving goals and savers who prioritise liquidity and accessibility over higher returns.

Very similar to instant access, easy-access savings accounts are suitable for savers who don’t want to commit to long-term saving goals and want to be able to withdraw their money at their discretion.

While there are no significant differences in the interest rates offered by the two types of savings accounts, easy-access savings accounts are slightly more limiting than instant ones.

For example, an easy-access savings account may be limited to a specific number of withdrawals per month. Moreover, consumers with easy-access savings accounts may be unable to withdraw larger amounts of money instantly without prior notice and may be subject to waiting periods.

Notice savings accounts are somewhat more restrictive than instant and easy-access savings accounts, but withdrawing from them is still possible, albeit significantly more inconvenient.

When consumers want to withdraw money from this type of savings account, they must notify the financial institution that offers the account, typically between 30 and 180 days in advance. In addition, they usually have a maximum withdrawal amount and a limited number of yearly withdrawals.

Furthermore, most notice savings accounts usually have a minimum balance requirement that the saver must meet before they start earning interest.

In return, their interest rates are considerably higher than those of the savings accounts that provide consumers with easier access to their savings. Moreover, some savers view the restrictive nature of notice savings accounts as an advantage as it prevents them from making impulse withdrawals but still allows them to access their funds in an emergency.

As you can probably guess, notice savings accounts are more suitable for savers who have longer-term savings goals and have a larger lump sum they want to earn interest on.

Similar to notice savings accounts, regular savings accounts are another type suitable for savers with longer-term goals. However, there is one key difference between them.

Instead of depositing one large lump sum and waiting for it to grow, regular savings accounts require savers to deposit a fixed amount on a monthly basis. So, besides the minimum balance requirements, they impose minimum deposit requirements.

Concerning withdrawal limitations, a few different options are possible. For example, some regular savings accounts are more restrictive and don’t allow early withdrawals. In contrast, others enable savers to withdraw some of their funds but reduce their interest rate in return.

Overall, regular savings accounts are ideal for consumers who are well-suited financially, have stable incomes, and have the necessary surplus cash to make monthly deposits.

Fixed-rate bonds, or fixed-term deposits, are the savings accounts that offer the highest interest rates but are also the most restrictive.

When a consumer deposits money in a fixed-rate bond, they typically can’t access their savings until the end of the term they previously arranged with the financial institution that offers the account. In some cases, they may be able to withdraw the funds earlier, but at the cost of a considerable penalty.

The period of time consumers can lock their savings away in a fixed-rate bond ranges from one to five years. The longer the period they commit to, the higher the interest rate they get.

Additionally, savers who deposit more considerable sums of money get higher interest rates than those who submit smaller deposits. In any case, all savers get a fixed interest rate and get their original capital plus the interest they earned at the end of the term.

Depending on their yearly wages, all savers have a personal savings allowance (PSA) set by the government. Consumers with higher wages get a lower PSA, while those with lower wages get a higher PSA. Moreover, consumers with the highest wages don’t get any tax-free allowance and must pay taxes on all interest they earn.

Individual savings accounts, more commonly known as cash ISAs, are a type of savings accounts that pay tax-free interest rates.

Regarding their restrictiveness and profitability, a cash ISA can provide instant or limited access to withdrawals or even be set up as fixed-term deposits, depending on the consumer's needs.

What’s more important is that the interest earned through cash ISAs does not count towards the tax-free PSA set by the government. Instead, they are limited by their ISA allowance, whose value changes yearly.

Now that we understand how the different types of savings accounts work, let's take a look at their advantages and limitations.

All things considered, savings accounts can be ideal for achieving all kinds of short and long-term saving goals. Here are a few examples illustrating the best ways to utilise savings accounts and their interest rates.

• Emergency Fund – A savings account is ideal for keeping your emergency fund. It is safe, insured by the government, easily accessible, and bears interest.

• Irregular Expenses – Some expenses, like car insurance premiums, are paid only once or twice yearly. However, you can put money aside in your savings account throughout the year and use it to pay them when they’re due.

• Building Up Buffer – People who are self-employed or work as freelancers may have incomes that vary from one month to the next. In such cases, they can use savings accounts to put money aside when they earn more and use the savings to cover the slower months.

• Saving for Taxes – Business owners can also use savings accounts to keep the funds for taxes and always be prepared for tax season.

• Saving for Big a Purchase – Instead of opening a line of credit, you can save up money for a big purchase in a savings account. Again, the interest rates can help you reach your saving goal faster.

• Saving for a Special Event – Just like big purchases, savings accounts are great for saving up money for special occasions like holidays, vacations, weddings, etc.

• Teaching Children About Saving – Opening a Junior ISA is the perfect way to teach your kids the importance of savings and instil healthy financial habits from a young age.

Of course, these are just our examples, and countless other ways to utilise savings accounts exist. If you have a specific idea in mind and want to open a savings account for yourself, the following section can help you choose the best option.

You want the funds deposited into your savings account protected with the highest level security measures and insured against unwanted scenarios. This is why you must consider only financial institutions authorised, regulated, and protected by the appropriate authoritative bodies.

Moreover, the FSCS only guarantees protection for amounts up to £85,000. Consider splitting your savings into multiple savings accounts if your savings exceed this amount.

Pay attention to the terms and conditions and make sure you read the fine print, as banks are infamous for “hiding” charges. For example, learn all the crucial details about the minimum deposit and balance requirements, withdrawal limitations, interest rates, etc.

Check for potential fees, charges, and other penalties. You don’t want to be caught off-guard and only learn about them after committing long-term.

Find out whether you will be able to access your funds and make an early withdrawal if it becomes necessary to do so. If early withdrawals are a possibility, find out how quickly they can be done and what are the penalties associated with them.

You want to be comfortable with the restrictions and limitations imposed by the financial institution, and if you are not, you should look for options elsewhere.

While you will most likely compare the annual interest rates offered by the financial institutions, there are other details about the interest rate you should also pay attention to.

• Ask if there are any minimum balance requirements associated with earning interest

• Find out if the interest rate being offered to you is fixed or variable

• Learn if the interest will be paid monthly and annually

Take all these considerations in mind, and choose the interest rate that works best for your financial needs and saving goals.

Trust funds are a popular alternative to savings accounts. They usually start to hold and manage assets on someone else’s behalf and provide unique legal benefits that savings accounts lack. However, they are considerably more expensive and more complex to set up than savings accounts.

Premium bonds are low-risk investment products offered by the government. Unlike savings accounts that incentivise saving with interest rates, premium bonds allow savers to enter a national lottery where they can win between £25 and £1 million tax-free. Then, if the savers need the money back, they can withdraw it anytime without paying a penalty or fee.

If you are looking for options that provide a higher return, consider investing in the capital market. Stocks, bonds, and plenty of other securities offer a significantly higher profitability potential than keeping money locked away in a savings account.

However, becoming an investor is different from becoming a saver. Unlike putting money in savings accounts, investing in such markets carries the risk of losing money and requires research and knowledge to succeed.