Santander 123 rate’s dropping to 1.5% – should you ditch it?

This Tuesday 1 November, Santander 123 – the bank account that’s topped savings tables for over four years – will take a hammer to the interest it pays. It’s cutting its main interest rate from 3% to 1.5%, the one that applies to savings up to £20,000. So the key question for the four million people who have it is – stick or ditch?

Five years ago the golden rule was, don’t keep any more money in a current account than needed – siphon the rest off into savings. Santander and others turned that upside down, by offering high interest rates on current accounts, as a way to draw in newbies. It worked. These new ‘savings bank accounts’ have dominated the savings best-buy tables ever since.

And it’s these accounts Santander 123 needs to compete with. I wrote my initial analysis back in August, just after Santander announced its interest cut on the back of the UK base rate dropping to 0.25%. You didn’t need a crystal ball to predict other savings bank accounts would follow suit. So my line was, ‘do nothing for now – keep earning the high 3% interest until the rate cut and I’ll redo the analysis then’.

This blog is me living up to that promise. Sadly, as predicted, since then we’ve seen savings bank accounts rates sliced more times than a salami.

– Club Lloyds, Halifax Reward and TSB Classic Plus have all recently announced they will slash what they pay if you’re in credit. These rate moves will hit at the beginning of January or February next year. See full rate cut info.

– We’ve also seen the rates of linked regular savings accounts cut on a whole range of other best-buy bank accounts too.

It’s important to note I’ve crunched the numbers based on the situation AFTER the cuts come into effect. If you’re a serious bank account tart, who’d prefer to grab the higher rates before they drop, you can glean what to do from my initial analysis blog linked above. For everyone else, read on…

Don’t bite off your nose to spite your face

Many people are furious about this rate cut and want to ditch the account to punish Santander. After all, it is cutting its rate by 1.5 percentage points, even though UK base rates only dropped by 0.25 percentage points. However, I’m going to ignore righteous indignation and instead focus on the numbers. There’s no point moving your cash elsewhere to punish Santander if the place you move it to will pay you less.

And, as I’ll explain, for some larger savers, depressingly, even at just 1.5% interest Santander may well remain your best option. However, what wins between different accounts is fiendishly complex. It relies on a complex interrelation between future interest rate moves, cashback earned, tax paid, the amount you have saved and more. I’ll try to guide you through that, but there is a little bit of art in this as well as science.

What will happen to the Santander 123 bank account on 1 November?

Big picture, the only change happening to Santander 123 is its interest rate. Its other features will remain as now. If you’re very familiar with this account, feel free to skip to the main ‘ditch it’ analysis; if not, here’s a summary and some tips on maximising your gain from it…

• THE BIG CHANGE: High interest on up to £20,000 (or £60,000 for a couple). The big sell of Santander 123 isn’t that its interest rate is far higher than other savings bank accounts’ – it’s that it allowed you to save far more than others at a high rate. Currently the interest works like this:
  
  – If you’ve under £1,000 in it, you don’t earn interest.
  – If you’ve £1,000 to £1,999, you earn 1% interest on the entire amount.
  – If you’ve £2,000 to £2,999, you earn 2% interest on the entire amount.
  – If you’ve £3,000 to £20,000, you earn 3% interest on the entire amount.
  
  From 1 Nov, it’s 1.5% FLAT interest from £1 up to £20,000.
  
  I suspect it has restructured this way so it can argue “there are some winners and some losers”, as all those with under £2,000 in it gain from the change. However, the big sell of this account has always been for larger savers, and indeed the average balance is over £11,000. Anyone with under £2,000 would’ve always been better off elsewhere anyway.
  
  The rate cut impact is huge. Currently, with the full £20,000 you’ll earn about £600 interest a year; from 1 November it’s roughly £300.
  
  Plus many have been taking advantage of the fact that you and a partner can each put £20,000 in an account, and then have a joint account – so that means you can save up to £60,000 between two of you. In that scenario the roughly £1,800 earned in interest is dropping to £900.

• NO CHANGE: Cashback on bills paid via the account. This can be substantial: a fair proportion of people earn over £500 a year. It pays…
  
  – 1% on water, council tax and Santander mortgage payments (up to £10/month on the mortgage).
  – 2% on gas, electricity and Santander home insurance.
  – 3% on phone, broadband, mobile and TV packages.
  
  But this only works if this is the account you pay all your bills from – so shift them to here. If you don’t pay bills (eg, parents do or partner does) and it’s not appropriate for them to be paid from your account, it’s far less attractive.
  
  I’m not surprised the cashback’s unchanged. After all, this is the Santander ‘123’ account, and by retaining the cashback structure it needn’t change its name. While the interest no longer fits the 123 branding, the cashback still does.

• NO CHANGE: There is a £5/month fee. This account has always had a fee. It was originally £2/mth but to many people’s annoyance, in January 2016, that increased to £5/mth. It lost a decent chunk of customers due to that (and I’m sure the same will happen with this change). However, even with the fee, for many with £5,000+ saved in it, this account still paid more than anything else.

• NO CHANGE: You can save £200/mth in its 3% AER variable regular saver. Santander 123 customers get access to its monthly savings account, which pays 3%. It already cut this rate from 5% to 3% back in August, so it’s unaffected by this news. While other bank accounts have higher-paying regular savers, if you have a 123 current account you may as well fill it up each month from your main bank account as it pays you more.

• BIG CHANGE: Overdraft costs to rise. I’ve written this blog mainly for savers. Yet if you have an overdraft, changes are coming too. Frankly, I hope this is irrelevant for most as Santander 123 has never been a good account if you go overdrawn (see Cut Overdraft Costs for better options).
  
  The change here takes place on 9 January 2017. All customers will still get a £12 overdraft buffer and their monthly overdraft cost will be capped at £95. However, the £1 a day arranged overdraft cost will change to:
  
  – £1,000 – £1,999.99 overdrawn. Fee will remain at £1 per day.
  – £2,000 – £2,999.99 overdrawn. Fee rises to £2 per day.
  – £3,000+ overdrawn. Fee rises to £3 per day.
  
  Do note it’s chosen to do a ‘123′ arrangement for the overdraft fees. This conveniently gives Santander a second element structured this way, to replace the lost ‘123′ of in-credit interest. It’s not great for those overdrawn to see such massive price rises, possibly just to justify its marketing.

Of course, to be eligible for the account, you’ll need pass a credit check and meet its terms, which is to put in £500/mth (though you can then withdraw it the next day) and have two direct debits set up – more on that in Top Bank Accounts.

How will Santander 123 rank at 1.5%?

Let’s start by doing some numbers. Below is a table of how the interest earnt in Santander 123 compares with other top savings products, after announced cuts.

 
As the table shows, as a single account choice, Santander 123 beats everything above £10,000 (before you deduct the fee), so if that’s what you want, it’s still a strong contender.

The next top contender is Bank of Scotland Vantage. It’s available across the UK online, and in its branches (including access only at the Halifax). It pays high interest on the first £5,000 and nowt above that. So why on earth would you keep the rest in there? (however, in saying that if you play it right you can have three of these accounts, see get 3% interest on £15,000). If you put the remainder in a top cash ISA or top normal savings, then combined these substantially beat Santander’s interest, especially for under £15,000.

So at this point, you may start being swayed towards ditching, and indeed the less savings you have in it, the stronger that sentiment should be. But before jumping there are five further factors you need to assess.

1. How much cashback you earn. I’ve assumed above that you earn enough cashback to roughly cover the monthly fee. If you earn less than that you should be even more keen to ditch Santander 123. However, from past polls I’ve done of Santander 123 customers, roughly two-thirds of 123 account holders earn cashback that matches or beats the £5 a month fee.
   
   And the more you earn, the more competitive the account is, even with just 1.5% interest, as the other high interest accounts don’t have this perk. Indeed if you earnt £10 a month cashback (so a net gain of £5 a month after the fee), then Santander 123 would beat the combined solution even with just £10,000 saved.
   
   
   
2. Will Bank of Scotland Vantage cut its interest rate? Its rate is unchanged since August’s UK base rate cut, which means this is a substantial question mark. When we asked, it said it has no current plans to. Yet that is far from a guarantee. The Bank of Scotland Vantage account is part of the same banking group as Lloyds and Halifax, both of which have cut rates.
   
   My suspicion is we’ll get an announcement within the next few months – but nothing is guaranteed. Right now inflation is on the up, which means further UK interest rate cuts are less likely, so Bank of Scotland may try to ride it out and take short-term advantage.
   
   If Bank of Scotland’s rate was no longer competitive, there is little to touch Santander 123 for larger amounts (above £15k) – even if you combined Tesco (which is also yet to announce a cut) or Club Lloyds (at its new lower 2% rate) with an easy-access savings account. As amounts grow, Santander 123 largely overtakes them.

• Most people’s interest won’t be taxed, but if yours is… All the calculations above assume you don’t pay tax on the interest – as since the introduction of the new personal savings allowance in April, 95% of people don’t earn enough interest to pay tax on it.
  
  To pay tax you need a serious wad of savings. As a basic 20% rate taxpayer you need to earn over £1,000 in interest a year, as a higher 40% rate taxpayer £500 interest a year, or if you earn over £150,000 a year and are a top-rate 45% taxpayer, all your interest is taxed. After the rate cut, even the maximum in Santander 123 won’t earn close to filling a higher-rate taxpayer’s allowance, so you’d still be a non-taxpayer.
  
  Yet for anyone whose interest is taxed, Santander becomes less attractive compared with cash ISAs (all the other savings listed above are taxed too, so its relative merits don’t change against those). The top easy-access cash ISA pays 1.1%, and its interest is tax-free, so everyone earns that.
  
  Here’s a table of the effective rate you earn if the interest is taxed. As can be seen, Santander’s interest rate only beats a top ISA for non- and basic-rate taxpayers.
  

• The need for certainty. Most standard easy-access accounts are a ‘variable rate’, meaning they can and do move both with the UK base rate and at providers’ whims. Santander 123 is a variable rate too.
  
  However, it’s likely this cut isn’t just happening because of the recent UK base rate move. At the point when Santander cut rates, the Bank of England was strongly signalling the rate of interest would continue to drop after that, possibly down to 0.1% or even 0% (let’s hope we don’t get negative interest rates as they have in Sweden or Japan).
  
  Santander has been reluctant to change the 123 rates too often, unlike a normal savings account. So it’s probably taken a hedge on the future direction of travel and gone lower than was predicted, so it doesn’t have to move again. That hopefully means that if the base rate was to drop slightly further, unlike normal savings accounts, it won’t change too often.
  
  The likelihood of further cuts in rates is less now than back in August when this was announced. Primarily this is because inflation is increasing, and to stave off inflation you’d normally increase rates (I’m not saying the Bank of England will do that, just it acts as a balancing factor against cuts). The fact the economy isn’t in quite as weak a position as predicted also makes further rate cuts less likely. Having said that, these things swing more than a toddler in a playground.
  
  It’s worth noting though, that if surety is really what you want and you don’t need ‘easy access’ so are prepared to lock cash away, then getting top fixed rate savings does that job, with the best one-year deal at 1.4%, and two-year at 1.55%. Though the one-year fix pays slightly less than Santander, if you weren’t earning enough cashback to cover the monthly fee, it wins.

• Are you willing to play the system? I focused my analysis above on having only one savings bank account. That’s because to do it, as well as passing a credit score, you need to have direct debits set up and ensure money is being paid in each month. Yet for those willing to play, it is possible to have more than one account, or a whole host of them. Here’s how to do it:
  
  – Open a new account. But, crucially, don’t use the switching service. This is because if you do it’ll automatically close your old account.
  
  – Make sure you can meet the number of standing orders/direct debits required. Transfer these across from your existing account manually.
  
  – Check the pay-in or other. Most will require a minimum pay-in per month, so just set up standing orders to move money between accounts. Some will also need you to jump through other hoops, like registering for internet banking, paperless statements or staying in credit.
  
  By doing this and combining Santander with the other top savings bank accounts you could save £37,000 at an average 2.16%.

So to cut to the chase, should you ditch Santander 123?

I hope the explanation above gives you enough to make that decision. Of course, I’ve based it only on a number crunch, not on customer service. If you like that, it’s another reason to stay (if you hate it, it’s another reason to leave).

However, I know some are nervous about this and would like some more direct instruction. That’s not easy to give, but here are four easy rules of thumb to start…

– If you’ve got less than £10,000 saved and don’t earn too much cashback DITCH.

– If you’ve got over £15,000 saved, earn about £5/mth cashback or more and want to keep it, simple, STICK.

– If you’re a higher-rate taxpayer, who pays tax on savings due to interest elsewhere (eg, fixed savings) and doesn’t earn huge cashback, DITCH it – you’re better off in a top cash ISA (unless that’s full).

If you’re not in one of those three categories then things get a little bit more complex, mainly because of the uncertainty over the Bank of Scotland rate.

– If you’ve between roughly £10,000 and £15,000 then generally, if you’re earning under £8 a month cashback, you should DITCH it. Though if your cashback isn’t that far from this, then the gain elsewhere won’t be huge, so you may decide to stick for ease. If you earn more cashback than that then STICK.

– If you’ve £15,000+ saved and earn a little cashback, you can gain if you DITCH at current rates, but it won’t be huge.

– If you’ve the full £20,000 and earn no cashback (as many couples will, who have it as a third account between them), then it’s likely you should DITCH this account, as you can earn more elsewhere.

I could go on, but of course it all boils down to…

Where should I move if I want to ditch?

For those with decent savings, the table above where I compare Santander with other savings bank accounts shows the best rates and options available. And of course the Top Savings and Top Cash ISAs guides run through this in more detail.

However, if you’ve smaller savings and are ditching it, there are a few other options to look at.

– If you get decent cashback. Check out the Santander 123 Lite account, which costs £1 a month, and pays cashback. See my Is Santander 123 Lite worth it? info. Having said that, if it’s cashback you want, then unless you’ve a Santander mortgage, you’ll usually be better off with the NatWest Reward account.

– Forget high interest savings bank accounts, and go for short-term gain. Take a look at either the Co-op Bank account which will pay you £150 to switch to it, then up to £5.50 a month on top in its Everyday Rewards scheme, or M&S Bank, which pays £100 of M&S vouchers for switching to it, plus £10 a month after that, and has a linked 5% regular savings account.

These are very lucrative for one year. In fact, when you add it up, you’ll earn more in these than in Nationwide’s savings bank account even though it pays 5% interest on up to £2,500 for the first year. Yet if you do either of these, as you don’t get any interest on savings, excess cash should be saved in a normal savings account, or ISA.

Arguably on short term, these accounts combined with easy-access savings can beat Santander 123 even for larger amounts, but of course here the gain is only for one year.

Some may also look at premium bonds with their current 1.25% prize rate. While a short-term gain is possible there, again I suspect we’ll see an announcement of rate cuts relatively soon (as NS&I which runs premium bonds isn’t allowed to offer rates which distort market competition).

What are you going to do?

I’d love to know what you plan to do with your Santander 123 account. Please let me know via the discussion boxes below or tweet me @martinslewis – do include roughly how much savings you have and what cashback you earn.