ISA interest rates different

SparciaM

First Direct are offering an ISA at 6% AER, but it goes on to say it's 5.84% tax free. Why do you lose 0.16% interest? I thought the whole 6% would be tax free?

Paul_Herring

You don't lose it - the 5.84% figure is the gross rate, which is paid monthly. If you leave interest in the account to compound it's 'as if' you were being paid 6% over a year.

If they only paid the interest yearly, then the gross rate would equal the AER rate.

SmileY_4

paul if im understanding you clearly:

5.84% is the interest rate.
£n would fetch (£n x 1.0584) after one month. Leave this in for a year you would effectively get (1.06*£n).

Yearly you would simply get (1.06*£n).

So the only difference is that in the monthly one you see gradual interest in the account ... the only purpose im presuming is if you wanted to take money out half way through? -- otherwise the figures are exactly the same?

Chris

Paul_Herring

SmileY wrote: »

paul if im understanding you clearly:

5.84% is the interest rate.
£n would fetch (£n x 1.0584) after one month. Leave this in for a year you would effectively get (1.06*£n).

Rather simplistically yes, though you need to divide the 5.84% by twelve to get a monthly figure.

See http://spreadsheets.google.com/pub?key=pNBpCyyhhED0j492GThy5Ow if it'll help any with the actual numbers.

The first block [A] shows what happens with a 6% gross applied annually, the last block [C] shows what happens with a 5.84% gross applied monthly - the end result is (within 5p) the same.

SmileY_4

ahh i see!

so technically then it is probably more sensible if given the option if you want monthly/annual to take monthly .... on the basis that after the year is up you will be getting much better returns on compounded monthly interest!

Paul_Herring

SmileY wrote: »

so technically then it is probably more sensible if given the option if you want monthly/annual to take monthly .... on the basis that after the year is up you will be getting much better returns on compounded monthly interest!

You'd think so, but no - any institutions that offers that choice use two different gross interest rates which negates any difference in the total interest over a year.

On the yearly interest one they'd offer 6.00% Gross/6.00% AER, on the monthly one they'd offer 5.84% Gross/6.00%AER.

Technically it's better to go for the yearly option, because if you close the account early you'll get (pence) more interest.

If you look at the end of June, for example, the yearly option will give you £29.76 interest, but the monthly option only has £29.32.