Setting up a savings goal

The best way to save money will depend on how much you need to save – and the amount of time you have to reach your goal. 

You might even have several goals, including short-term goals such as a holiday, medium-term goals such as a deposit to buy a house, and long-term goals such as a retirement income.

This article reviews the different options and offers some tips on how to start saving to make your dreams come true.

How to save towards a savings goal

With any savings goal, you need to work out how much spare income you can put towards your target amount each month.

That way, you can calculate how long it is going to take you to reach your goal.

Say you want to save up to pay for a holiday that is going to cost £1,200. If you can save £100 a month towards this goal each month, you’ll be able to jet off on your trip in one year’s time. 

But if you can only spare £50 a month for this savings goal, you’ll have to wait two years before going on your dream holiday.

If your savings goal has a set date, perhaps because you need to attend a wedding overseas, you can also use this to work out how much you need to save each month to attain your target. 

If, for example, you have 14 months to save up £1,200, you’ll need to stash away about £86 a month to have enough for the trip.

The best ways to save towards a short-term goal

Once you know how much you want to save each month, it’s a good idea to set up a Direct Debit or Standing Order into a savings account – ideally shortly after your pay lands in your current account. That way, you won’t have time to spend it unnecessarily.

That said, it’s not worth getting into debt to meet a savings goal, as the interest charged on debts such as overdrafts is generally much higher than that paid on savings accounts. 

So, if you run out of money at the end of the month, it’s usually a better idea to dip back into your savings than to go into the red.

Therefore, for a short-term goal, you need an account that pays a high rate of interest and lets you have penalty-free access to your cash when you need it.

Regular savings accounts

If you have 12 months or more to hit your savings goal, one of the best places to put your money is a regular savings account. These generally run for 12 months and pay fixed interest rates that are higher than easy access or fixed-rate savings accounts. 

However, they also come with more rules. There is, for example, usually a minimum, say, £10 to £20, and a maximum amount of about £250 you can invest each month. 

With most accounts, you will lose interest if you fail to pay in at least the minimum each month. You’ll also face penalties if you need to withdraw your money within 12 months. 

This is good for preventing you from dipping into your savings pot unnecessarily but makes regular savings accounts unsuitable as “rainy day” funds. 

High-interest current accounts

Some bank accounts' in-credit interest rates can beat easy-access savings accounts and ISAs on a certain amount, say £2,000 or £2,500. At the time of writing, you can earn up to 2.5% in accounts of this kind.

To benefit, you’ll need to switch your current account, or at least pay in a minimum amount of, say, £1,000 a month. 

Some high-interest current accounts also impose other conditions, such as having to take out a linked savings account, to earn the headline interest rate.

The best ways to save towards a medium-term goal

When saving towards a medium-term goal such as a new kitchen, you need to look for an account that will allow you to save a larger amount. 

Tax considerations may come into play as a result, potentially making ISAs a more attractive home for your money.

Thanks to the Personal Savings Allowance, you can earn up to £1,000 a year in interest tax free as a basic-rate taxpayer or £500 if you pay tax at the higher rate. 

But additional-rate taxpayers pay tax on any savings interest not earned within an ISA. 

Lifetime ISAs

A Lifetime ISA is a great place to save up for a deposit to buy your first home, as long as you’re aged between 18 and 39. 

You can also use one to save towards retirement, again as long as you open an account before your 40th birthday.

Either way, you can save up to £4,000 per tax year into a Lifetime ISA, either as a lump sum or by adding to your balance throughout the year. 

The government then adds a 25% bonus on top. So, if you save the full £4,000, you'll have at least £5,000 by the end of the first year.

After 12 months, first-time buyers can use the money towards the purchase of any residential property costing up to £450,000. 

Retirement savers, meanwhile, must wait generally until they are at least 60 to make a penalty-free withdrawal.

Fixed-rate cash ISAs

A fixed-rate cash ISA can also be a good choice – as long as the length of time you can’t access your cash fits with your savings goal timeline.

As long as you’re at least 16, you can shelter your returns on up to £20,000 from income and capital gains tax in an ISA each tax year.

As with fixed-rate savings accounts, you’ll receive a fixed rate of interest for a set period and will be penalised if you need to make a withdrawal within the term. 

The best ways to save towards a long-term goal

When you have a long time, say more than five years, to attain your savings goal, a savings account may not always be the best home for your savings.

Over time, investments tend to outperform savings accounts – especially when interest rates are low. 

However, the value of investments can go down as well as up, which is why some people prefer the security of a savings account such as a fixed-rate cash ISA.

Stocks and shares ISAs

Stocks and shares ISAs can be used to invest in company shares, unit trusts and investment funds, corporate bonds, and government bonds. 

Like all investment accounts, they come with an element of risk. But over the longer term, they should usually beat savings account returns.

You can only open one stocks and shares ISA per tax year, but you can split your £20,000 ISA allowance between a cash ISA and a stocks and shares ISA.

Pensions 

Pensions offer attractive tax advantages, but they can only be used to save for retirement as you are unable to access the money before you reach the age of say 60 or 65, depending on the scheme.

If you’re employed, you’ll probably have a workplace pension into which you can pay more if you wish. You can also top up your retirement savings by opening a personal pension plan.

Your withdrawal options at retirement include receiving a regular income and withdrawing a tax-free lump sum.