The monthly rate is normally a little lower than the annual rate because it’s paid more frequently. If the interest stays in your account, it builds on itself (compounds), so the annual rate works out higher.
Let’s say you put £1,000 into a savings account with an interest rate of 5% AER.
- After 12 months, you’d earn £50 interest, so your balance would be £1,050.
- If you left it in for another year at the same rate, you wouldn’t just earn £50 again. You’d earn interest on your £1,050 - meaning your pot grows faster.
This projection is for illustrative purposes
That’s why providers use AER. It shows you how much your savings could grow in a year, including compounding (interest on interest), so it’s easier to compare accounts. AER shows you that total yearly return in one clear number. In other words, AER gives you a fair way to compare different accounts and see the real return on your money.
Compound interest is when the interest you earn also earns interest. It’s like a snowball effect - your balance grows, and then the new, bigger balance earns even more.
Here’s a simple example:
- You save £1,000 in an account paying 2% interest.
- After one year, you’ve earned £20, so your balance is £1,020.
- In the second year, you don’t just earn interest on your original £1,000 - you also earn it on the extra £20.
The longer you leave your money in, the more powerful compounding becomes. That’s why AER, which takes compound interest into account, gives the most accurate picture of how your savings grow. It means you don’t need to worry about how often interest is paid. Just look at the AER and you’ll know which account will give you the best yearly return.
Not all savings accounts offer compound interest, so be sure to check this when you are comparing accounts. For example, you will need to check whether the interest is paid to the account or not. Savings accounts that pay monthly interest, the interest is usually required to be paid into another account you have with your provider or third-party provider in order to withdraw it.
Benefits:
- Makes it easier to compare savings accounts and investments
- Shows the real return by including compound interest
- AER is a standard measure across all banks and building societies
Key considerations:
- Doesn’t reflect fees or withdrawal penalties
- Assumes you keep your money and all interest in for a full year
- Can be slightly confusing, as AER is one type of interest rate, there’s potential to get rate terms mixed up. But don’t worry we explain some other types below.
The gross rate is the basic interest rate an account pays before tax and without compounding. It shows how much you’d earn if you only looked at the percentage applied to your deposit.
The AER goes a step further. It includes compounding and shows your total annual return if you reinvest the interest.
So, while the gross rate might be 2%, the AER could be 2.02% if interest is paid monthly and into the account. It might not sound like much, but over time, especially with larger balances, those small differences add up.
| Term |
What it means |
Example |
| AER |
The annual return including compound interest. Standardised so you can fairly compare accounts that pay monthly, quarterly or annually. |
A 2% gross rate paid monthly into the account works out as 2.02% AER - £20.20 interest on £1,000. |
| Gross rate |
The basic interest rate before tax or compounding. Shows the ‘headline’ rate an account pages. |
A 2% gross rate paid once a year gives you £20 interest on £1,000. |
| Net rate |
The interest you actually receive after tax (if your earnings go above your Personal Savings Allowance. |
£200 interest taxed at 20% leaves you with £160 net. |
Think of AER as a guide for comparison. It helps you see which account could give you more, but your real return depends on how you use the account.
A high AER can look tempting, but there are other things to think about too:
- Tax: Will you pay tax on the interest you earn?
- Access: Do you need to dip into your savings or are you happy to lock them away?
You can save tax-free by using:
