• Another lockdown means for many people cash is going to be piling up in their current accounts
• £120 billion was saved into bank and building society accounts between March and November 2020, up from £42 billion in 2019*
• £220 billion is now sitting in cash accounts paying no interest*
• The average current account is paying just 0.13% interest, while the best instant access savings rate is 0.75%**
• 5 ways to use your lockdown cash
*source: Bank of England
** sources: Bank of England, Moneyfacts
Laith Khalaf, financial analyst at AJ Bell:
“With pubs, restaurants, gyms and cafes shut for the next month, there’s going to be few outlets for spending, so many Brits will find cash building up in their bank accounts.
“While it’s definitely good to have a cash emergency buffer, a current account is almost certainly one of the worst places to keep it, because these products are built for transactional functionality, rather than as a home for savings. Consequently, interest rates tend to be lousy.
“The typical interest rate on current account balances is now just 0.13%, and that’s from those that actually pay any interest. A year ago that rate stood at 0.38% and five years ago it was 1.11%. Meanwhile the amount of money held in instant access accounts paying zero interest has ballooned to £220 billion.
“Savers can’t do anything about the economic situation that has prompted such low interest rates, but they can take concrete steps to improve their own lot. Shopping around for better cash rates, paying down debt and considering investing some of their savings in the stock market are all tangible levers savers can pull.
“Cash rates look set to remain low for some time and markets are actually pricing in a 50% chance they could sink lower this year. Sitting tight and hoping that interest rates will improve simply isn’t a strategy, it’s the lack of one.”
5 ways to use lockdown cash
1. Pay down credit cards
“Paying down expensive debt is one of the best investments you can make. The average interest charged on credit card balances currently is over 17% (not including accounts that charge no interest). By paying this off you are effectively getting a 17% guaranteed return, and that compares with getting 0.13% on average for money sitting in a current account. There’s just no comparison.
“You may well be able to get such a return without committing any cash, by transferring expensive credit card debt to a provider who is offering 0% on balance transfers. You will need to qualify for the account, but if you can switch from paying 17% to 0% with a bit of paperwork, that’s a no-brainer.”
“The introductory offer of 0% will only last for a limited period, after which much higher rates start to apply. So by that time make sure you have either paid your debt off, or have found another provider offering 0% on balance transfers you can switch to. You also need to factor in any fees charged for the balance transfer, or ongoing fees for the credit card.”
2. Pay down your mortgage
“After you’ve paid off more expensive debt, it’s worth considering overpaying your mortgage. The yield on doing so will depend on the mortgage interest rate you’re paying and indeed the rate you will pay in years to come, which isn’t quantifiable right now. However, with interest rates so low, it doesn’t seem likely mortgages are going to get significantly cheaper, though it’s best never to say never where monetary policy is concerned.
“The average mortgage interest rate right now is 2.1%, which compares favourably to the best rate you can get on an instant access savings account, which is 0.75% according to Moneyfacts. Even locking away in a 5 year bond only gets you 1.25% (Moneyfacts), so again the return you get by paying down a 2.1% mortgage looks favourable.
“Mortgage rates obviously vary depending on the provider, term, and when you took them out, so check what rate you are paying. And there is a big BUT- many mortgages will only allow you to overpay a certain amount each year before you start to incur punitive charges, so you may find there is only a limited amount of cash you can funnel in this direction.”
3. Actively manage your cash
“Shopping around for the best rate on your savings is always a good idea. The Moneyfacts best buy for an instant access account currently pays 0.75% per annum, compared to an average rate of 0.13% on current accounts and zero on accounts paying nil interest. 0.75% is not a great return by any stretch of the imagination, but it’s better you have the extra cash than the bank.
“You should also consider locking away your money for longer in a fixed term bond to harvest higher rates. Normally the longer you lock your money away for, the higher the rate you will get. However, that picture is a little distorted at the moment because there are some expectations in the market that there will be an interest rate cut.
“Clearly if you lock away for longer, you have less access to your cash. There’s also the risk that interest rates rise, leaving you stuck on an uncompetitive rate. On the flip side, if rates fall, the bank still has to pay you the higher locked-in rated. It’s like a fixed term mortgage, in reverse.
|
Moneyfacts Best Buy |
|
|
Instant access |
0.75% |
|
6 month bond |
0.60% |
|
1 year bond |
1.00% |
|
18 month bond |
0.95% |
|
2 year bond |
1.04% |
|
3 year bond |
1.00% |
|
5 year bond |
1.25% |
Source: Moneyfacts, based on £25k lump sum
“As things stand, there’s no great benefit in locking your money away for more than one year, unless you’re prepared to do it for five years and even then, the additional yield is 0.25% a year. That doesn’t look like a great deal of compensation for relinquishing access to your money for an extra four years and for the risk interest rates may rise in that time.
“The 1 year bond looks worth considering, if you don’t need access to the money in the next twelve months, as it yields you 0.25% more than the best instant access account and it’s a relatively short time you don’t have access to the cash. And compared to an account paying no interest, that’s an extra £100 on £10,000 cash in one year.
“It’s worth keeping an eye on the fixed rate bond market every now and then, because rates do move around based on market expectations of interest rates. If there is a strong economic recovery, or inflation starts to climb, we can expect rates on fixed term bonds with longer maturities to rise.
“Savers also now have access to services like the AJ Bell Cash savings hub, which allow customers to compare savings accounts and switch between them all in one place, without having to fill in an application every time.”
4. Consider Premium Bonds
“While NS&I has slashed rates on many of its most popular accounts, Premium Bonds still look like a decent option, as the interest rate on the prize pool remains higher than the best easy access account right now. On top of that it’s tax-free so anyone who’s used up their personal savings allowance would actually need to get an even higher rate from a standard taxable account to match the post-tax interest from Premium Bonds, as below.
|
New Premium Bond rate |
Equivalent taxable rate required for taxpayers on |
Best buy* |
||
|
Basic rate |
Higher rate |
Additional rate |
||
|
1% |
1.25% |
1.67% |
1.82% |
0.75% |
*Moneyfacts easy access best buy 06/01/2021
“Unlike a traditional savings account of course, Premium Bond interest is not distributed evenly, so you may get more or less than the interest rate applied to the prize pool, depending how lucky you are. Indeed that is part of the appeal of Premium Bonds, particularly when interest rates are so low everywhere - there’s a small chance you might get a humungous return on your investment by winning one of the big prizes, including two £1million jackpots each month.”
4. Set up an ISA
“Every year you have an ISA allowance which allows you to put £20,000 out of the clutches of the taxman. The benefits of doing so depend on which of the main two ISAs you choose- Cash or Stocks and Shares.
“Cash ISAs allow you to receive interest tax-free. However, for many people this might not be so different to a normal savings account, seeing as there is currently a personal savings allowance of £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. With interest rates as low as they are, you would therefore need a lot held in cash to start to pay tax.
“For instance, even at 1% interest, a basic rate taxpayer would need a cash sum of £100,000 and a higher rate taxpayer a cash sum of £50,000 before they started to pay tax. (Additional rate taxpayers don’t get a personal savings allowance, so for them a Cash ISA wrapper is definitely valuable compared to an ordinary savings account).
“Add into the mix the fact that rates on Cash ISAs are often lower than other savings accounts and that raises a big question mark over whether a Cash ISA is worth it. The current Moneyfacts best buy for an easy access Cash ISA is 0.6%, compared to 0.75% from a standard savings account and 1% from Premium Bonds (which are also tax-free).
“However, there are still good reason to consider a Cash ISA. First, tax-free allowances like the personal allowance aren’t set in stone and future governments could change them, for better or worse. Second, interest rates won’t stay low forever. Admittedly this isn’t happening any time soon, but if interest rates were 4%, many more people would find their personal savings allowance inadequate. For instance, in this scenario, a basic rate taxpayer would start paying tax on cash savings above £25,000 and a higher rate taxpayer on savings above £12,500. Thirdly, if in future you decide you want to invest your money, Cash ISAs can be converted into Stocks and Shares ISAs without using any more of your ISA allowance.
“So, while you might not get the very best rate from a Cash ISA, there is an element of future-proofing in using your allowance. Savers should have a think about how valuable this is, depending on their personal circumstances and tax status.
“Stocks and Shares ISAs are free from income tax and capital gains tax, though of course you must be willing to invest for the long term (a minimum of five to ten years), and be prepared to ride out the ups and downs of the stock market.
“Unlike a Cash ISA, the return you get on an investment (e.g Fundsmith Equity fund) inside an ISA is the same as holding it outside, and the tax treatment is likely to be more favourable too. Annual dividends above £2,000 are taxable if not held in an ISA (or pension) and with the UK stock market tending to yield between 3% and 4%, it won’t take a huge portfolio to make the ISA shelter worthwhile, particularly if you factor in stock market growth. Gains are also free from Capital Gains Tax, so if you have some big winners, you get to keep more of the profits.
“The deadline for Cash ISAs and Stocks and Shares ISAs for this tax year is, as ever, 5th April.”
5. Top up your pension
“Another option if you’re able to leave your money invested for the long term is to top up your pension. You’ll get tax relief of 20%, 40% or 45% on your contribution, depending on whether you’re a basic rate, higher rate, or additional rate taxpayer. If you earn between £100,000 and £125,000, the effective rate of tax relief is actually 60%, because pension contributions mean you also get back £1 of personal allowance for each £2 you put in.
“The investments you make within the pension are free from income tax and capital gains tax, though you can’t draw on the money until you are at least 55. When you do draw your pension, 25% can be taken as a tax-free lump sum and the rest is taxable at your marginal rate at the time.
“In the first instance, check if your employer will match any additional contributions you make. If they do it will probably be on regular savings rather than lump sums, so you’ll need to ask to increase your monthly contributions. For some schemes, there are only certain points in the year you can do this. If you’re employer doesn’t match contributions and you want a wider investment choice than your workplace pension offers, a SIPP might be the way to go. In a SIPP you can invest in active funds, index trackers, ETFs, investment trusts and individual shares.
“Either way, lockdown means you might not be able to spend much in your free time now, but if you stick in it a pension, it has time to grow and fund some enjoyment in retirement.”
