Important: This article is for general guidance purposes only and should not be considered as financial advice. Tax treatment will depend on your individual circumstances and could potentially change in the future.
Points of interest
Gross? AER? What does it all mean? It can be tough to understand the different kinds of interest rates you might encounter as you look for a way to maximise your savings.
One key point is the difference between gross interest and the annual equivalent rate (AER). This guide will get you up to scratch.
What is gross interest?
To put it simply, gross interest is the amount of interest you would earn on savings annually as a percentage. The figure shown is always without tax deducted. For example, gross interest of 4% would accumulate £400 annually on savings of £10,000.
Since the introduction of the personal savings allowance (PSA) in April 2016, interest has been paid gross, without income tax deducted. Read more about the PSA.
One way to avoid going over your PSA — or, at the very least, reducing your tax bill — is to put your savings in a cash ISA, as you never have to pay tax on interest earnedon ISAs. Read more about cash ISAs and how they work.
Regardless of how you choose to save your money, it’s important to remember that it’s your responsibility to pay any tax you owe on interest to HMRC. Failing to do so could result in a penalty.
Knowing your gross from your AER
Like gross interest, AER is the rate you’ll receive before tax is deducted; the only difference is that it takes ‘compound interest’ into account. Compound interest means that, when you save money, in addition to earning interest on the savings, you also earn interest on the interest itself.
Let’s say you have £10,000 in a savings account offering 4% AER compounded annually. After a year of saving, you’d earn £400 interest; after five years, your balance would be £12,166.52, assuming you hadn’t withdrawn from your savings in the meantime. This is because you would be earning interest on both the principal amount of £10,000 and interest on the subsequent savings.
This is how your savings would perform over the five-year period.
Year | Interest earned each year | Total cumulative interest earned | Value of savings |
|---|
1 | £400 | £400 | £10,400 |
2 | £416 | £816 | £10,816 |
3 | £432.64 | £1,248.64 | £11,248.64 |
4 | £449.94 | £1,698.58 | £11,698.58 |
5 | £467.94 | £2,166.52 | £12,166.52 |
For illustrative purposes only
The above table is calculated on the basis that your interest will be added once a year. In this instance, the AER and gross interest rate would be the same. However, some providers will add interest to your savings at more regular intervals — every month or quarter, for instance. The more regularly that interest is paid, the greater the difference between the AER and gross interest rate.
For example, if a savings account is advertised as having a gross interest rate of 4% that compounds every 180 days, this would be equivalent to an AER of 4.04%. If interest is paid every 90 days, then it would be equivalent to 4.06%; every month, and it would be equivalent to 4.07%.
On the other hand, if a product is advertised as having an AER of 4% and the interest is compounded every 180 days, then the gross rate would be 3.96%. It would be 3.94% if interest is paid every 90 days and 3.93% if paid monthly. You can determine these figures using an AER to gross interest calculator. Put simply, AER offers a snapshot of how the money in your account increases as a result of the interest you earn over time.
While AER can be used as a metric to determine how savings should grow over a time period, it doesn’t take into account any withdrawals or charges that might be applied for withdrawing.
Some providers will only allow you to make a certain number of withdrawals each tax year, and if you go over the limit then the interest rate may drop. Our Cash ISA is easy access, meaning you have unlimited withdrawals, plus we won’t reduce your interest rate for making withdrawals. This is why it’s imperative that you always check the terms and conditions of a product before applying for it.
Another phrase to watch out for - ‘variable AER’
A phrase you’ll often see when comparing interest rates is ‘variable AER’, which is what we offer with our Cash ISA. This simply means that the rate offered can go up and down depending on factors such as the Bank of England base rate.
Variable AER rates were slightly higher than fixed AER rates in October 2024, although the opposite is typically true because variable rate products are often easy access. This means there are fewer restrictions when it comes to depositing and withdrawing.
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