Reader Question:
I would like to start saving for my children's education which will start in 10 years time. I have an initial lump sum of £10,000 and would like this to reach about £35,000 at the end of the ten years. What is the best way to do this? What kind of account should I be looking for that will let me pay money in monthly and then take out the cash when needed in the future? Is it possible to get an account with a high interest rate?
My response:
Based on the fact that you want to save the money and stay in control of it, rather than invest it, then using cash ISAs would be an idea. Cash ISAs differ from normal savings accounts as they allow you to save without paying tax on any interest earned.
Ordinarily savings interest is taxed at your marginal income tax rate. How this works in practice is that your bank pays you your interest with 20% already deducted – the swines! Then if you are a high rate tax payer (40% or 50%) you have to pay the balance (a further 20% or 30%) via your tax return.
What this means is that while the rate you think you are getting is the gross advertised rate in reality you get at least 20% less.
For example, if the interest rate is stated as 4% then a basic rate tax payer will only receive 3.2% net of tax. But a 40% tax payer will have to pay even more tax via their tax return meaning that they in reality only receive 2.4%. Non-tax payers can receive their interest on ordinary savings accounts tax-free if they complete an R85 form at their bank.
Step forward cash ISA’s!
Any interest earned on a cash ISA’s is paid tax-free! Why? It’s government’s way of trying to encourage people to save. But the silver lining has a dark cloud – namely that an individual can only invest £5,640 per tax year. Savers wishing to save more than that in a given tax year will either have to also use ordinary savings accounts or get their spouse to use their cash ISA allowance. But it's not all good news, as recent research has shown that some banks are effectively keeping the tax relief on cash ISAs for themselves by offering better rates on their ordinary savings accounts!
The dangers of chasing rates
The important thing is to shop around and find the best savings rates (be it ISA or normal savings accounts). Sites such as Money facts can help you quickly search the market.
If you do have a look around then make sure you compare like with like. Some savings accounts offer eye catching introductory bonuses to lure you in. But after the offer ends you can end up on a fairly naff rate. Or they limit withdrawals.
Also make sure that there are no account opening restrictions and how regularly interest is paid out. The longer you tie your money up (without access or loss of interest on early withdrawal) the better the interest rate. But don’t forget, what looks attractive now may not be in a few years time. The Bank Base rate is at an historic low so the only way is up from here. And when rates do go up savings rates will follow.
It’s easy to just go with the bank with the highest interest rate but ask yourself the question why is it so good? It is likely that they are desperate for your money and have to offer eye-catching rates to persuade investors to part with their cash. Shortly before Iceland’s Kaupthing bank collapsed in 2008 they were offering market leading rates. Any investor who jumped in with both feet got a nasty shock. See my article Money Tip #100 – The dangers of chasing the best savings rates for more on this.
I suppose what I’m trying to say is that every financial decision, no matter how seemingly simple, should be given the necessary care and attention.
For more information on investing and saving for children see my post Saving and Investing for Children.
I hope that helps
Damien
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