Data from CACI, which compiles adult savings account information from 26 providers, showed the net flow of money into fixed-term accounts was £39.5bn in the period between 2 January and 9 April 2023.
On the other hand, instant access accounts saw a drop in popularity, with a near £30bn net outflow during the same period.
Soaring interest rates are likely the biggest driver behind the current fixed-term boom, but are there any other benefits to locking your savings away for at least a year? Here, Which? weighs up the pros and cons of opening a fixed-term account.
Pros
Higher rates
The main attraction to opening a fixed-term account is the significantly higher rates offered to savers who are prepared to lock their money away for a set period.
After years of poor returns, following the financial crisis in 2008 and the Covid pandemic, fixed-term rates are now soaring and almost double where they were this time last year.
According to Moneyfacts data from 2 May 2022, the top five-year fix offered 2.75% AER. Fast-forward to 11 May 2023 and the rate for two, three, four and five-year accounts are all set at 4.95%.
The parity in rates may come as a surprise to savers who might expect better returns the longer they tie their money up. However, providers are currently adjusting rates according to predictions as to what will happen to the Bank of England's base rate in the future.
In other words, banks don't want to be stuck paying savers nearly 5% interest over the next few years if it looks like the base rate is going to drop to less than that well before the account matures.
Interest offered by instant access accounts is also high, the best rate pays 3.71% AER. Although it's around three times what it was in May 2022, it's still more than a percentage point behind all the top fixed-term accounts.
Find out more:Guaranteed interest
What goes up must come down, but the rate you're offered when you open a fixed product will stay the same for the duration of the term. This isn’t the case with instant access, where rates can change at any time.
Your provider should give you notice of any interest changes – and if rates do take a dip, you might need to switch elsewhere to make sure you're still getting a competitive rate.
Can’t spend the cash
Once you've locked your money away in a fixed account, most providers won't allow you to touch it until the term is up. That usually includes adding to the pot as well.
The upside here is that it removes the temptation to dip into your savings; instead, you can allow your money to steadily grow over time.
Cons
No access to cash
While tying your money up in a fixed-term account may curb your temptation to spend your savings, it also means you won't be able to use the funds in an emergency.
Some providers won't allow customers to access their account before it reaches maturity, while others will only allow you to break the contract in exceptional circumstances. In some instances, you can close or make a withdrawal early in exchange for a loss of interest.
For example, providers charge interest penalties typically between 90 and 365 days. If you've only had the account for a year and you pay a 365 day interest penalty, it won't have grown at all. It's important to consider whether a new account would be able to make up for this loss before the end of its term.
Can't switch to a better deal
An increasing number of providers are paying almost 5% AER for fixed-term savings accounts. And as the Bank of England raised the base rate for the 12th time in a row on 11 May, we may see savings rates climb even higher.
However, those who opened a fixed-term account before the rates rocketed may be frustrated at being stuck with a shoddy low rate of interest and unable to switch to a better deal.
For example, just a year ago, the best rate available for a two-year fixed-term account was 2.36%, nearly half the current best rate of 4.95%. If you'd committed to a five-year account last May, the highest interest on offer was similarly low at 2.75%. Now it's also 4.95%.
Let's suppose you took out a five-year fixed-term savings account last May, depositing £10,000 at the top rate of 2.75%. Compared to the interest you could earn today, you'd be down around £1,329 in interest after five years.
That said, don't panic if your fixed-term rate is being beaten by the latest accounts. Yes, you are missing out on potential interest, but you'll also have to forfeit interest if you try to leave the account early (if you're even allowed to, that is).
Find out more:You might have to pay tax on interest earned
One snag to higher interest rates is that the interest earned in a savings account is taxable. The personal savings allowance means basic-rate taxpayers can earn up to £1,000 a year in savings interest tax-free, while higher-rate taxpayers get a £500 limit. Additional-rate taxpayers have no personal savings allowance.
In a climate of low savings rates, these allowances have been more than enough for most savers not to worry about exceeding them. But the higher rates rise, the easier it will be to end up with a tax bill.
So, if you're a basic-rate taxpayer and were to invest £20,000 in an account paying 5% AER, you could expect to earn just over £1,000 in a year, which would exceed the personal tax allowance. At the same rate, a higher-rate taxpayer would exceed their £500 allowance with just £10,000 saved.
Find out more: undefinedsource https://www.which.co.uk/news/article/the-pros-and-cons-of-fixed-term-savings-accounts-aKDzv2m3g2Jf