Should you lock your money away for seven years?

Interest on fixed-term accounts is plummeting, so savers need to act fast to grab a top deal. With rates expected to continue falling, is now the time to lock-in for as long as possible?

Shorter-length accounts still offer the best rates, but fixing for five or even seven years could mean your money earns a higher rate even when interest on new bonds falls.

Here, Which? takes a closer look at what's happening to the savings market and whether opening a long-term account is wise in a climate of falling rates.

Rates are falling fast

After hitting record highs in 2023, rates on fixed savings have taken a nose-dive. 

As of 1 February 2024, the average one-year fixed bond stood at 4.62% AER, according to Moneyfacts data. That's a dramatic drop of 0.82 percentage points from its peak of 5.44% on 1 October 2023. Average rates on longer-term fixed accounts have seen even sharper falls, plummeting 1 percentage point from a high of 5.12% AER on 1 September 2023 to 4.12% on 1 February 2024.

The widespread rate cuts we are seeing on fixed savings bonds are likely down to the Bank of England's decision to freeze the base rate at 5.25% and an expectation that it will start to fall at some point in the near future. 

Is it worth fixing for longer?

Savvy savers with an eye on the market might therefore move to lock in an interest rate now before things get any worse. The question is, how long should you fix for? 

One-year bonds currently offer the best returns - the top one offers 5.2% AER and is from Allica Bank - but you might end up with a lower rate if you choose to reinvest the cash when the account matures. 

On the other hand, a bond of five or more years provides peace of mind that your nest egg will be protected from the impact of falling rates for longer.

The longest bond offered by most providers is usually five years. The best deal for that is 4.5% AER from Atom Bank. Moneyfacts data, however, shows it's possible to lock your cash away for as much as seven years. 

Which? analysis found only four banks offering this option - Isbank, Shawbrook Bank, Bank of London and The Middle East, and UBL UK. All of the seven-year bonds offer above-average rates, with the top deal of 4.5% AER coming from Isbank, available through savings platform Raisin UK.

• Find out more: best savings accounts

Perks and perils of fixing long-term

Opening a fixed bond may guarantee you the same interest rate for the term, but it's not for everyone. To help you make the right decision, here are the main pros and cons of locking your money away:

No access

Once you've locked your money away in a fixed account, most providers won't allow you to touch it until the term is up. That usually includes adding to the pot as well. The upside here is that it removes the temptation to dip into your savings; instead, you can allow your money to steadily grow over time. But it also means you won't be able to use the funds in an emergency.

Some providers won't allow customers to access their account before it reaches maturity, while others will only allow you to break the contract in exceptional circumstances. In some instances, you can close or make a withdrawal early in exchange for a loss of interest.

For example, providers charge interest penalties typically between 90 and 365 days. If you've only had the account for a year and you pay a 365-day interest penalty, it won't have grown at all. It's important to consider whether a new account would be able to make up for this loss before the end of its term.

Tax on interest

If you have a large lump sum to invest, you could end up with a tax bill. 

The personal savings allowance means basic-rate taxpayers can earn up to £1,000 a year in savings interest tax-free, while higher-rate taxpayers get a £500 limit. Additional-rate taxpayers have no personal savings allowance.

It means a basic-rate taxpayer opening the best seven-year fix at the rate of 4.5% AER, would end up paying income tax on interest earned with around £22,223. If you're a higher-rate taxpayer, the tipping point drops to just £11,112.

• Find out more: tax on savings explained

Can't switch to a better deal

While rates are currently falling and there's no sign of that shifting now, five to seven years is a very long time. Consider how much has changed in just the last few years. For example, the average rate on a one-year fix on 1 February 2021 was just 0.46% AER and 0.68% for a long-term bond.

Those who opened a longer fixed-term account before the rates rocketed will still be stuck with a shoddy low rate of interest and unable to switch to a better deal. 

• Find out more: how to switch your savings account