Monthly V Annual interest. Will I ever understand?

fimonkey

I understand that when comparing savings account you look at the AER as that is regardless of whether interest is paid monthly or annually, but does it assume that interest paid monthly is withdrawn?

Reason I ask, is that Birmingham Midshires have a 1 year internet fixed rate bond that pays 7.11%AER. They state this to be a net rate of 5.51% if interest is paid monthly, or 5.69% if interest is paid annually.

But surely, if I go for monthly interest, and do not take out any of the funds (which is a condition of the bond, that access cannot be gained for the full one year) then I would earn interest on my interest, and therefore earn more overall? But if this was the case, how come it looks more attractive to go for yearly interest (when comparing net figures).

So therefore I guess that interest paid monthly in this case has to go to another account (cannot be added to existing savings)?

But then if that's the case, how come the net is less for monthly interest than for yearly? Surely if I have 10K in a 1 yr bond, and interest is calculated daily, then there are the same number of days overall regardless of whether it is yearly or monthly?

Overall, as a BR tax payer with ISA allowance fully used, I'm interested in the net amount of interest (regardless of AER) so ultimately wonder why I get a better net amount of interest with yearly payments as opposed to monthly payments of interest?

Can you see why I'm so confused? SIMPLE answers please, I'm clearly a dunce with this one.

Lokolo

AER is the annual equivilent rate.

You get paid less on monthly interest as the interested is compounded and therefore leaving the account alone you will earn the same amount as you would with yearly interest. Therefore making no difference. It does not consider the interest being taken out of the account when considering AER.

The only difference between monthly and yearly is if you pay tax. Monthly you will be paying interest tax monthly and therefore making the compound interest less than what it could be. Yearly you only pay it once and therefore no effect with compound interest.

nilrem_2

The only difference between monthly and yearly is if you pay tax. Monthly you will be paying interest tax monthly and therefore making the compound interest less than what it could be. Yearly you only pay it once and therefore no effect with compound interest.

Fair to point out that the 'tax difference' is very small, I always go for monthly interest which is paid into my current bank account, that way the interest is available rather than being 'tied up' for up to a year, I can make use of the interest if I wish and any surpluses can be reinvested in a high interest savings account such as Icesave where it can earn more interest.

In some cases taking monthly interest can earn more than annual interest, for example if you go for a fixed interest account with annual interest that interest rate is fixed for the term, but if you select monthly and there is a rise in interest rates it is possible to reinvest your monthly interest received at a higher rate thereby gaining an advantage.

magicdogsbrain

fimonkey wrote: »

I understand that when comparing savings account you look at the AER as that is regardless of whether interest is paid monthly or annually, but does it assume that interest paid monthly is withdrawn?

Reason I ask, is that Birmingham Midshires have a 1 year internet fixed rate bond that pays 7.11%AER. They state this to be a net rate of 5.51% if interest is paid monthly, or 5.69% if interest is paid annually.

But surely, if I go for monthly interest, and do not take out any of the funds (which is a condition of the bond, that access cannot be gained for the full one year) then I would earn interest on my interest, and therefore earn more overall? But if this was the case, how come it looks more attractive to go for yearly interest (when comparing net figures).

So therefore I guess that interest paid monthly in this case has to go to another account (cannot be added to existing savings)?

But then if that's the case, how come the net is less for monthly interest than for yearly? Surely if I have 10K in a 1 yr bond, and interest is calculated daily, then there are the same number of days overall regardless of whether it is yearly or monthly?

Overall, as a BR tax payer with ISA allowance fully used, I'm interested in the net amount of interest (regardless of AER) so ultimately wonder why I get a better net amount of interest with yearly payments as opposed to monthly payments of interest?

Can you see why I'm so confused? SIMPLE answers please, I'm clearly a dunce with this one.

Very little difference between 5.69 annual and 5.51 monthly - slightly better annual.

Monthly interest
1000
1056.9
1004.592
1009.204
1013.838
1018.494
1023.17
1027.868
1032.588
1037.329
1042.092
1046.877
1051.684
1056.513

Annual interest 1056.9

(interest on £1000 is £56.51 monthly interest or £56.9 annual)

Paul_Herring

nilrem wrote: »

Fair to point out that the 'tax difference' is very small,

On £1000 at 6% it works out to 27p for a basic rate tax payer, and 36p for a higher rate: http://spreadsheets.google.com/pub?key=pNBpCyyhhED0L42bCUZCgWA

Apreciar

Paul_Herring wrote: »

On £1000 at 6% it works out to 27p for a basic rate tax payer, and 36p for a higher rate: http://spreadsheets.google.com/pub?key=pNBpCyyhhED0L42bCUZCgWA

Surely the higher rate tax rate is a red herring as this is not taxed at point of interest but at the year end in your tax return. So the compounding is at the 20% rate for all; or am I missing something?

Edit: Sorry Paul-Herring the red herring comment was not an intended pun, only saw your name after I posted

[Deleted User]

Apreciar wrote: »

Surely the higher rate tax rate is a red herring as this is not taxed at point of interest but at the year end in your tax return. So the compounding is at the 20% rate for all; or am I missing something?

Agreed. My understanding was a default of 20% was deducted from your interest unless you submitted an R85 form then you'd get gross interest. You then pay the rest of the tax at the end of the financial year...

Paul_Herring

Deleted_User wrote: »

You then pay the rest of the tax at the end of the financial year...

Or if you're unlucky, upfront with a pre-empive change to your tax code like HMRC did with me one year.

But yes, the chart is slightly misleading in that higher rate payers don't normally pay 40% at source.

Paul_Herring

Paul_Herring wrote: »

But yes, the chart is slightly misleading in that higher rate payers don't normally pay 40% at source.

I've added a note to the spreadsheet to this effect (I've used it in the past, and will no doubt find other threads to use it on.)