How do interest rates work on savings accounts?

Key points:

• Interest rates help your savings grow over time, rewarding you for keeping money in your account
• Different accounts offer varying rates, so it’s worth checking which suits your needs best
• Compounding means you earn interest on both your original deposit and previous interest. This helps your savings grow faster as time goes on.
• Tax may apply to savings interest, but tax-free options like ISAs could let you keep more of your earnings
• Consistent saving, even in small amounts, can strengthen your financial position in the long run

Curious about why your savings account balance seems to grow, even when you haven’t added any extra cash? Put simply, an interest rate is the percentage your bank pays you for keeping your money with them. Most savings accounts come with an interest rate – shown as a percentage of your total balance over a set period, usually a year. This means your money can earn a little extra while it sits in your account, and the interest you earn is your reward for saving.

How do interest rates work?

Interest rates are essentially the price your bank pays you for keeping your money with them. Think of them as the “growth rate” for your savings. Here’s how it works:

• Annual equivalent rate (AER): This is usually shown as a percentage (e.g., 3% AER). It tells you how much you’ll earn over a year, taking into account any compounded interest (but more on that later). Often you’ll see banks express this alongside gross interest, which is the rate used to calculate your interest payments, which doesn’t take compounding into account. UK banks pay interest as gross, so the interest you get could still be taxed.
• Different accounts, different rates: Easy-access, savings accounts with competitive rates (like Chase’s saver) have their own rates. Current accounts, however, may not pay interest, so check your provider’s terms. You can usually find these rates in your online banking app or on your bank’s website.
• Rates may change: Some rates may change while others stay the same. You’ll usually see this shown as ‘variable’ or ‘fixed’. Variable means the rate can go up or down, while fixed means the rate will stay the same for a set period.

You can see what saver rate you’re currently getting by logging into your Chase app (Opens in new tab)and tapping on your account.

How you earn interest on savings

When you deposit money in your savings account, the bank may use it to fund loans and other activities. In return, they pay you interest. It’s a win-win!

Imagine:

• you open a savings account and put in £1,000 on your first day
• the interest rate of the account is 4.5%
• you make no withdrawals
• the interest rate stays the same

You’ll earn £45 in interest over the year, meaning your balance would be £1,045 after one year. That’s your money working a little harder for you.

Compounding interest

Compounding interest is when you earn interest not just on the money you put into your savings account, but also on the interest you’ve already earned. It’s earning interest on your interest.

Here’s how it works using the same 4.5% AER example:

• Year 1: £1,000 x 4.5% = £45. Your total is £1,045
• Year 2: £1,045 x 4.5% = £47.03. Your total is £1,092.03
• Year 3: £1,092.03 x 4.5% = £49.14. Your total is £1,141.17

The longer you leave your money, the more it adds up over time, because of compounding.

Tax on savings interest

The standard for UK banks is to not take off any tax before paying your interest. However, interest you earn on your accounts is taxable in the UK. How much interest you can earn before paying tax depends on your income tax rate and other circumstances.

The good news is that if you use a tax-efficient product like an Individual Savings Account (Opens in new tab) (ISA), the calculated interest could work in your favour.

The real power of saving isn’t just about setting money aside – it’s about letting your money work for you through interest and compounding. Even small amounts can grow into something meaningful over time, especially if you choose the right account and let your savings stay put. No matter where you are on your savings journey, every contribution you make can help you build a stronger financial foundation for the future.

Please remember that tax treatment depends on individual circumstances and may change in the future.

The Hub is intended as a knowledge portal to provide information on a range of topics, including financial products and lifestyle management. Articles may refer to products and services which Chase UK does not currently offer.

As with all investing, your capital is at risk. The value of your portfolio can go down or up and you may get back less than you invest. Tax rules vary by individual status and may change.