Switch an existing fixed rate account from compounding to paying away to benefit from higher rates?

Desk

If someone has a sum of money locked into a multi-year fixed rate savings account at a rate now lower than the current high rates, is it a good idea, where the account allows, to switch the annual option on interest from 'compound' to 'paid away' - so as to benefit from better rates outside the account?

For example, if you have money in a three or five year fixed rate savings account offering 5% AER, then the annual interest automatically reinvested back into that account will itself just benefit from a continuing 5% rate.

Whereas, if you are able to switch to have that interest paid away annually, then right now you could potentially reinvest the entirety of that sum into a new, higher-paying multi-year account.

I know there's the issue of tax on interest earned above a certain sum.

However, it's my understanding that taxation is applied annually to the payee within the year in which the interest is potentially available - which is annually in the case of accounts where you can choose to switch between compound and paid away each year. So the tax owed on interest would have to be paid in that year anyway, likely applied to the payee's tax code? It's not that you *really* get to compound untaxed interest until the maturity of the account?

Any thoughts on this? Am I missing something?

Desk

t1redmonkey

I've been doing that since January this year personally, been using the interest to put in higher interest rate Regular Savers.  I had a secondary reason as well; I needed the interest paid out to be able to fund my ISA allowance for this year (which I've recently done by closing some of those regular savers I had been paying into).

My plan now I've maxed my ISA allowance is to keep having the interest I'm getting paid out and I will keep funding Regular Savers, and then possibly in a few months time withdraw/close from them if it makes sense to do so, and fund a new fixed rate bond instead (if rates are still high, which they probably will be).