Should you fix your savings?

Is it always a good idea to tie up your funds?

Savings rates are significantly higher than they were two years ago but they’ve been falling for some time now. And and with the Bank of England set to keep reducing the base rate in 2025, that could continue.

But does that mean you should opt for a fixed-rate savings account to protect you from tumbling rates?

Potentially, yes.

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What is a fixed-rate savings bond?

In a nutshell, it’s a savings account that guarantees a rate of interest for a set period of time – usually between one and five years, though shorter and longer terms are available.

During that time you can’t usually access your money so before opening a fixed-rate savings bond you need to be sure you can do without your savings for that time.

What are the benefits of a fixed-rate bond?

Guaranteeing an interest rate is a real draw, especially when rates are falling or when the economy’s a bit uncertain (which is most of the time, let’s be honest).

These accounts give you certainty, and protect you when interest rates drop. Often, though not always, fixed rate accounts pay more than easy access options. 

At the time of writing, you can earn 4.8% if you lock up your money for 12 months compared to the top easy access account which pays 5.17% – but you’ve got the reassurance the fixed rates won’t change. 

For some people, setting money aside that they can’t touch helps them save towards future goals without the risk of dipping into it. 

They’re also safe. Open a fixed-rate bond with a provider that’s covered by the Financial Services Compensation Scheme (FSCS) and up to £85,000 of your savings will be protected if the firm goes bust. 

And what are the cons?

For a start, if interest rates go up elsewhere, your money in fixed-rate bond won’t benefit as that rate is locked in.

You also won’t be able to make withdrawals in the vast majority of fixed rate accounts. One key exception are fixed rate ISAs, when you’ll pay a penalty in interest to take money out early. But otherwise, you can’t access money in a fix until it matures.

Having limited or no access to your money could be a blessing for some people – and a disaster for others. 

Anyone’s financial circumstances can change at any time. Make sure you have three to six months’ outgoings saved in an easy-access fund before even considering locking up your money for an extended period of time, so ensure you can cover any emergency expenses.

Once you’ve put your money in the bond, you can’t usually make any more deposits. So if you’re wanting to regularly save, you’ll need to put the money elsewhere.

What about tax?

If you’ve got your money fixed for a year or more, you’ll need to be mindful of tax being due on the interest you earn. 

Basic rate taxpayers get a Personal Savings Allowance (PSA) of £1,000 a year, which is tax-free. Higher rate taxpayers have a £500 a year allowance while additional rate taxpayers don’t get a PSA. Savings interest above your allowance is charged at your usual rate.

Any tax applies when you can access your funds – so you could be hit with it at the end of the term of a fixed rate bond. 

Say you have a five-year bond paying 4.45% on £10,000. If the interest was added to your balance each year you’d earn almost £2,490 over the five years. 

With this example, if you’re a basic rate taxpayer, you’d exceed your PSA by £1,490 and be charged 20% tax and if you’re a higher-rate taxpayer you’d owe 40% tax on £1,990.

But, if you opt for a bond where the interest is paid into a separate account each year – or ‘paid away’ – you could avoid tax or pay far less. 

Using the example above, if you opted to pay the interest away, you’d move £445 into a separate account each year. This is within your annual PSA whether you’re a basic or higher-rate taxpayer.

Now, with paying away you’ll earn less interest overall than if you kept it in the account (thanks to compounding) but you’ll need to work out whether the tax you end up paying is worth it. And of course you can also reinvest the interest into a new savings account so it keeps earning interest.

When should I get a fixed rate savings account?

You can lock down your savings at any time, but it’s worth considering when you want to secure a rate for a set period of time. 

For example, right now we’re expecting the base rate to fall over the next few years. That’ll mean that both variable and fixed rates will keep dropping. So even if an easy access pays better than a fix at the moment, it could be that in a year’s time those variable rates will be far lower than locking in right now. But it’s never a guarantee that rates will actually fall. 

You also need to compare the return on a fixed rate account versus what you could potentially get elsewhere, say from investing or overpaying on your mortgage. Recently savings rates around 5% have been very attractive from that perspective, but the lower they get, that might not be the case. 

As mentioned, it’s always worth having emergency funds in an accessible account. But fixed savings accounts are quite an attractive option when you have a decent amount of money you want to put aside for a specific goal in the near-ish future, say one or two years.

They’re also worth considering if you’ve suddenly come into money, for example you’ve received some inheritance, which you don’t have plans for in the next year.

For smaller amounts, you may want to consider a regular savings account. These pay up to 7% at the moment and are also usually fixed for 12 months. However you can only usually only pay in a couple of hundred pounds a month which means the interest you earn will be limited. 

What are my alternatives?

You could consider a fixed-rate Cash ISA. The rates might be slightly lower than the equivalent savings bonds, but unlike with bonds, all the interest you earn is tax-free and you can make withdrawals during the term – subject to a penalty fee. 

For money you won’t want to access for at least five years, you could look at investing instead. Or you can always contribute to really long term savings, such as your pension.