Annual vs monthly interest on an ISA

innovate

Have you read and understood this: http://www.moneysavingexpert.com/banking/interest-rates#AER. Plenty of other places to google for AER if you want other opinions.

Bottom line though is that the AER of a savings account is 100% the same, regardless of how often you are paid interest throughout the year.

jamesd

innovate wrote: »

Just looked for the @psychology function in my Excel spreadsheet. It is not there. Do I need to install an upgrade (I am on V 12.0.6611.1000) ? Am I losing interest payments because I have a backlevel Excel?

You might also think that pensions auto-enrolment is pointless if you don't understand the behavioral economics behind it.

innovate wrote: »

Surely what Nationwide pays out on interest monthly over a 12-month period is precisely the same amount of money as they will pay out in annual interest over the same period?

No, it isn't, because they have to pay interest on less money.

innovate wrote: »

Bottom line though is that the AER of a savings account is 100% the same, regardless of how often you are paid interest throughout the year.

The AER is the same but for a taxable account the interest paid isn't the same. The AER calculation ignores the effect of tax, pretending it isn't being deducted.

innovate wrote: »

As the AER is the AER, regardless of the frequency of interest payment.

If the money was left in a non-taxable account that would be correct. Other than a bad attitude to being corrected, the problem you have is that the money isn't left in a non-taxable account, it's paid into a different, taxable, account. The interest on the interest in that taxable account is subject to tax. That means the interest on the interest is lower and the total amount paid out is lower.

It's really easy to understand:

month 1: ISA pays £1000 of interest tax free into taxable savings account.
month 2: Taxable savings account pays gross interest of say 1% a month for convenience, on £1000, £10 of interest. Tax of £2 is deducted, leaving £8 of this interest in the account.
month 3: Instead of paying interest on the £10, NW has to pay interest only on the £8 of after tax interest. And on the £1,000 of course, but that's not the part that matters.

Now, I trust that you can see that NW paying interest at exactly the same rate on £8 instead of £10 means that NW will pay out less in interest and the recipient will receive less interest.

But, you might think, what about the tax being paid annually, that's also taxable. And you're be right. But the tax is due when the interest is paid. And that means that until the end of the year the tax in annual form is getting interest paid on the gross interest, not the net interest. So there's more interest paid on the higher before tax accumulation.

If you still don't get it, I suggest you get out that copy of Excel and create a spreadsheet that works out the monthly interest for a taxable account and a non-taxable account and then notice that the total at the end of the year is lower for the taxable monthly payment one than the untaxed monthly payment one.

The MSE article you've referenced on AER just shows you're confused about why there's a difference. It's not the compounding difference, it's whether the compounding is before or after the deduction of tax. The AER corrects for the compounding part, but not for the different tax treatment. The article isn't particularly helpful because it could have explained that you get less interest paid in a monthly account than in an annual one if it's a taxable account.

The difference can also be eliminated by paying the interest paid into the taxable account back into the ISA as soon as it's received. Then the second month's compounding will be inside the ISA and no tax will be deducted. Repeat each month and then the numbers will be the same for monthly and annual interest payment.

innovate wrote: »

Just looked for the @psychology function in my Excel spreadsheet. It is not there. Do I need to install an upgrade (I am on V 12.0.6611.1000) ? Am I losing interest payments because I have a backlevel Excel?

Surely what Nationwide pays out on interest monthly over a 12-month period is precisely the same amount of money as they will pay out in annual interest over the same period? As the AER is the AER, regardless of the frequency of interest payment.

I wonder how much interest 'Zero Sum' gets on the current account. Though would hazard a guess that it is substantially below the ISA interest rate, even if 'Zero Sum' is a non-tax payer. Most probably it is a big fat zero, since we are talking about Nationwide who haven't paid any interest on their Flexaccount ever since I took an interest in Flexaccounts (about 7 years ago now).

Cute, but being right trumps trying to ridicule those who correctly correct you. What it shows instead is that you're too weak to accept being corrected when the inevitable happens and you get something wrong. That's a character flaw and I wish you luck in getting rid of it, because it makes you a less capable person than you could otherwise be.

innovate wrote: »

Give a man a fish and he can eat for a day. Teach a man to fish, and he can eat for life. Chinese proverb.

It's a lot easier if the person being taught doesn't fight each correction but instead asks a simple question: "why?" when someone corrects them and they don't understand the reason.

kiwisaver2012

I have a virgin money instant access ISA that pays monthly interest. I understand that I get a slightly lower rate to account for the compounding effect (2.82% monthly compared to 2.85% annual).

The interest is paid straight back into my ISA and to be honest I assumed it wouldn't be counted towards my ISA limit, so I'll have to check the conditions. But it makes sense it wouldn't be because it hasn't been deposited by me, I guess.

I chose monthly:
A) because I like to see how much interest I am earning on a monthly basis (I have the spreadsheets going but it's not quite the same as seeing the cash coming in!) so it is psychological for me.
You can see immediately when your rate goes down - I know not an issue for my virgin ISA which is in fact the reason I chose virgin. I hate the bonus rates with a passion - the cynic in me thinks banks do this (both bonus rates and annual interest) on purpose to keep you in a low paying account for longer - a combination of apathy and just not realising.
and C) In NZ all savings accounts (that I was aware of - things may have changed) had monthly interest - I am just not used to it, and hadn't seen it until I came over here (and this applies to bonus rates as well). Because I'm not used to it the annual interest on your savings account just seems weird! Why don't the banks pay monthly by default? So they can hold onto your money for longer? (the cynic in me coming out again!)

opinions4u

Why don't the banks pay monthly by default? So they can hold onto your money for longer? (the cynic in me coming out again!)

Most savings accounts have small balances. There is a (small) cost to adding interest and a slightly larger cost to sending it to an account elsewhere.

Why choose to have twelve times the cost when the customer demand for it is relatively low?

innovate

QUOTE=kiwisaver2012;56095663]....to be honest I assumed it wouldn't be counted towards my ISA limit, so I'll have to check the conditions. .....[/QUOTE]
Interest payments do not count towards your ISA allowances. Nor do transfers-in. Only money that you deposit counts.

kiwisaver2012 wrote: »

I chose monthly:
A) because I like to see how much interest I am earning on a monthly basis (I have the spreadsheets going but it's not quite the same as seeing the cash coming in!) so it is psychological for me.

I know a year can be a long time but as long as the T&Cs say you get x% AER, you do get x%AER.

Strange thing, psychology - - - seems you like to receive lots of small payments, whilst I am quite happy to store it all up for one big payment. If both of us save in the same account for the same time in the same savings account, we do get the same amount of interest. Fair enough, if you need to spend your interest before the year is up, you might be better off with monthly interest payments (all depends on the T&Cs). And if it suits you psychologically to see your interest on your bank balance monthly rather than annually, that's fine too - - other people like to see one big payment less frequently, but bottom line it's all the same.

If you don't need your ongoing interest to support your spending, it doesn't matter if they don' t pay you more than once a year. You aren't losing out financially.

kiwisaver2012 wrote: »

I hate the bonus rates with a passion

They are prevalent now. As always- - if you can't beat them, join them! So just play the transfer game once a year. You might even win doing that.

kiwisaver2012 wrote: »

Why don't the banks pay monthly by default? So they can hold onto your money for longer?

You could take that further - - why don't they pay weekly, daily, hourly, by the minute, by the second? All a question of cost - - it's better for the customer if the banks can keep their costs down. As long as you get the originally advertised AER, you shouldn't need to worry. Your AER is likely to be higher if the cost to the bank

jamesd

kiwisaver2012 wrote: »

I understand that I get a slightly lower rate to account for the compounding effect (2.82% monthly compared to 2.85% annual).

In a tax free account the compounding still happens and the amount ends up the same, except for possible rounding differences. It's only in taxable accounts that there's a difference for tax payers.

kiwisaver2012 wrote: »

The interest is paid straight back into my ISA and to be honest I assumed it wouldn't be counted towards my ISA limit

It doesn't count. The original account discussed here was just unusual because it paid the interest outside the ISA and that would have required using some of the allowance to get it back in. So long as the interest is paid directly into the ISA, as it almost always is, no more allowance will be used.

kiwisaver2012 wrote: »

I chose monthly:
A) because I like to see how much interest I am earning on a monthly basis ... so it is psychological for me.
You can see immediately when your rate goes down...
C) In NZ all savings accounts ... had monthly interest

All good reasons, though do note that you really do get a bit less interest if you use monthly on a taxable account.

kiwisaver2012 wrote: »

I hate the bonus rates with a passion - the cynic in me thinks banks do this (both bonus rates and annual interest) on purpose to keep you in a low paying account for longer - a combination of apathy and just not realising.

It's a form of price discrimination, just like using different brands, vouchers or sales. It's a way to charge/pay less to the customers who care less about price while still getting the business of the ones who care more. Part of the wonderful world of behavioral economics as companies seek to maximise revenue by exploiting customer psychology.

You're using some of the same sort of behavioral psychology on yourself, recognising that you find monthly encourages you, so preferring that option.

opinions4u

It's odd. Some people dislike bonus rates.

I prefer rates with a low base and a high fixed bonus.

That way there's a guaranteed minimum rate for a set period of time that the bank cannot sneak below.

With a "clean" rate they can cut rates whenever they want, subject to the T&Cs.