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Interest Rates - Savings Accounts

In the context of savings and investments, interest is money added to your savings by your savings account provider. Your savings earn interest in return for you depositing your funds with a specific bank or building society. The amount added is determined by the 'interest rate'. The interest rate is the yearly percentage by which your savings will increase. An interest rate of six percent means that at the end of one year you would have one hundred and six percent of your initial deposit. Therefore, if you deposit $1,000 at the beginning of the year, it will have grown in value to $1,060 by the beginning of the next year.

The interest rate applied to your account will generally reflect the base interest rate. This is the interest rate that the Reserve Bank of Australia uses for its own transactions, sometimes known as the official Bank Rate. The base interest rate may change every month, though if it does it is usually only by a small amount (often around 0.25 %). If it does change drastically, it is generally at the discretion of your savings provider whether they pass this change on to you or not.

Interest on cleared funds is usually calculated after the end of each working day and paid monthly, quarterly or annually. If paid monthly or quarterly, an Annual Equivalent Rate (AER) will be given to demonstrate what the estimated gross interest paid would be if it were paid and compounded annually. Gross and net interest rates are usually published in line with fluctuations in the Reserve Bank of Australia`s base rate, although some banks promise a guaranteed interest rate for a fixed-term period. For example, you may be promised an interest rate of one percent more than the base rate for a period of two years. The net interest rate is the gross interest rate offered, minus tax at the basic tax rate.

If you are a taxpayer, tax will be deducted from the interest earned on your savings. The interest rate that you will receive will therefore be the net interest rate. The net rate is published along with the gross interest rate and is calculated as follows:

Gross Interest Rate – Basic Rate of Tax* = Net Interest Rate

*The Basic Rate of Tax is 30% as of April 2015

Interest is paid on cleared funds. 'Cleared funds' and 'cleared balance' refer to the money in your account that has completed all the necessary security checks to verify its authenticity as a transaction. When paying into your account, the money may be shown as immediately available, although it has not fully 'cleared'. 'Clearing' is the name given to the process of completing the transaction, which includes all the necessary security checks. The time taken for funds to clear is variable and depends on the transaction involved. For example if transferring from a current account to a savings account with the same provider, the clearing process may be completed the same day.

There is no limit on the interest you can earn on a cleared balance. However, interest earned is subject to income tax at the usual tiered levels (unless saving in a tax-free account – see Other Savings Accounts for more information). These levels are currently 30% (basic rate) or 50% (higher rate); the one at which you are charged will depend on your total taxable income. There is also a personal tax-free allowance. If you are a non-taxpayer or your earnings are subject to the higher rate of tax (40% as of April 2008), you will be responsible for managing your own taxes, including making extra payments and requesting rebates. Non-taxpayers should apply for the appropriate form from the tax office so that gross interest can be paid on your savings by your account provider, whilst higher-rate tax payers must declare any income earned on savings so that the extra tax payable can be calculated (further information regarding this tax declaration and your personal situation can be obtained from the Australian Taxation Office (ATO) – latest information is available via their website at www.ato.gov.au). As a higher-rate tax payer it is your sole responsibility to declare this income, failure to do so could involve heavy fines and even a custodial sentence. An account holder can register that he or she is tax exempt by returning the appropriate tax form to the tax office.

It should also be noted that the account balance often determines the level of interest earned; many banks and financial institutions offer accounts with a staged interest level, increasing interest earned on the balance when the balance exceeds specified limits. This is often referred to as a 'tiered' interest rate. These interest rates will usually only offer an advantage to savers who intend to invest a large amount in their savings account. Doing so will entitle these savers to earn interest at the higher rate. If you intend to save a small amount, you may find that a savings account which offers flat-rate interest offers you better investment returns than you would receive from a tiered interest savings account.

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