AER, gross and fixed or variable rates explained

When a savings account advertises a rate, the figure you see is almost always an AER. AER stands for Annual Equivalent Rate, and NS&I's guidance defines it as a measure that "illustrates what the annual rate of interest would be if the interest was compounded each time it was paid"¹. In plain terms, it answers one question: if I put money in this account and leave it alone for a year, what yearly rate does that work out to?

The reason AER exists is comparison. Two accounts might both advertise the same rate, but if one pays interest every month and the other once a year, the monthly one earns slightly more over the year, because each month's interest itself starts earning interest. AER smooths that out into a single yearly percentage so the two can be compared like for like. StepChange's glossary puts it simply: "AER shows you what the interest would be if it was paid once a year"².

This page explains what AER means, how it differs from the gross rate, what it leaves out, and how variable rates behave. It uses worked examples with real figures so you can see how the numbers translate into pounds.

What AER means: the Annual Equivalent Rate

AER stands for Annual Equivalent Rate⁶. Yorkshire Building Society's guidance explains that it "illustrates what your interest rate would be if interest was paid and compounded each year and allows you to easily compare different savings accounts"⁶. HSBC makes the same point from the other direction: all banks and building societies show their interest rate as AER, precisely because it lets customers compare accounts on a consistent basis⁷.

The mechanics are straightforward. Interest can be compounded daily, monthly, quarterly, annually, or for any other period⁸. Whatever the actual payment schedule, AER restates the rate as if interest were paid and compounded once a year. Halifax's glossary describes it in exactly those terms: "It shows what the interest rate would be if your interest was paid and compounded once each year"⁹.

AER is always shown as a percentage⁶. It also factors in compound interest, which HSBC defines as "any interest you earn on top of interest you've already been paid"⁸. That is the whole point of the measure: without it, an account paying interest monthly could look worse on paper than one paying the same rate annually, even though the monthly account might produce more interest over a full year.

Where interest is paid once a year, nothing needs adjusting. NS&I's guidance states that "where interest is paid annually, the quoted rate and the AER are the same"¹. The two figures only diverge when interest arrives more than once a year, which is when compounding starts to do its work.

A related phrase you will see is "per annum". Halifax explains that per annum means annually, and that the annual rate is "normally known as AER (Annual Equivalent Rate)"¹⁰. Conister Bank uses the same framing, describing AER as the rate "if it was paid and compounded each year"¹¹, and TSB notes that AER is what allows different savings accounts to be compared¹². So when a provider quotes a rate "per annum" alongside an AER, the two are describing the same yearly basis.

The practical use of AER is set out by Chip's glossary: "It allows you to compare different savings account options and understand the true return you can expect over a year"¹³. That comparison only works if the AER figures are being used for accounts of the same type, a point covered later on this page under where AER stops.

A worked example: how £1,000 grows

The clearest way to see AER in action is to follow a single balance through a year. Yorkshire Building Society gives the headline example: "if you saved £1000 with an AER of 4%, after a full year you would have earned £40 in interest"⁶. The AER tells you the end result, regardless of how often the interest was actually paid along the way.

As an illustrative example, take £1,000 in a savings account with an AER of 3.00%, with interest paid yearly and no further deposits or withdrawals. After one year the balance would grow to £1,030¹⁴. Because AER factors in compound interest, the interest you earn on top of interest already paid, the second year earns slightly more than the first, and the third slightly more again, so the balance grows at an increasing pace the longer the money stays put¹⁴.

Notice what happens in year two. The interest is still 3%, but the earnings rise from £30.00 to £30.90, because the second year's interest is being calculated on £1,030 rather than £1,000. That extra 90 pence is compound interest: interest earned on interest already paid. By year three the effect is larger still, at £31.83¹⁴. Chip's glossary gives the same starting point from the other direction: £1,000 in an account with an AER of 3.00% grows to £1,030 after one year, assuming no additional deposits or withdrawals¹³.

Yorkshire Building Society extends its example beyond a single year. If the original amount plus the £40 of compound interest is left for another year on the same terms, the saver receives a further £1.60 in interest⁶. That £1.60 is the second year's compounding on the first year's earnings.

Two practical points follow from these examples. First, AER assumes the money stays put: deposits and withdrawals during the year change what you actually receive. Second, compounding only shows up in the figures when interest is added to the balance rather than paid away to you, which is why the same headline rate can produce slightly different outcomes depending on how the account works. The dedicated page on compound interest covers the calculation in more depth.

The gross rate is paid before tax, not tax-free

The gross rate is the rate before anything is taken off it. NS&I defines it plainly: "Gross is the taxable rate of interest without the deduction of UK Income Tax"¹⁵. Chip's glossary gives a worked sense of the figure: £1,000 in a UK savings account with a gross interest rate of 3% earns £30 in interest over a year, before any taxes or charges are applied¹⁶.

The word "gross" is often misread as meaning tax-free. It does not. TSB states that "Gross rate means that credit interest is paid without income tax being deducted"¹², and Lloyds makes the same point for its own accounts: "we won't remove tax from the interest we pay on money in your account"⁵. The tax position is yours to settle. Halifax's glossary notes that "depending on your personal circumstances, you may need to pay tax on the interest you earn and it will be your responsibility to pay any tax you may owe to HM Revenue and Customs (HMRC)"⁹.

In practice, many people owe nothing, because most savers can earn some interest tax-free under the personal savings allowance and the starting rate for savings. Chip's glossary makes the general point that "the actual amount you earn will be lower than the gross rate due to any applicable deductions, such as tax"¹⁶, but whether any deduction applies depends on your income and allowances. The pages on how tax on savings interest works, the personal savings allowance and the starting rate for savings set out those rules.

Genuinely tax-free interest exists, but it comes from specific products rather than from the word "gross". NS&I's Direct ISA, for example, is advertised at 3.80% tax-free/AER, variable¹⁷, and the same figure appears on its ISA page¹⁸. An ISA's interest is free of income tax, which is why providers label it "tax-free" rather than merely gross. The comparison between cash ISAs and ordinary savings accounts turns on exactly this difference.

The relationship between gross and AER also matters here. Yorkshire Building Society states that "AER accounts for compound interest, gross interest does not"⁶. Lloyds gives the rule that follows from it: "If your bank pays and compounds interest more than once each year, the AER will be higher than the gross interest rate"³. So on a monthly-interest account you will normally see two figures, a gross rate and a slightly higher AER, and the gap between them is the effect of compounding.

Where AER stops: fees, conditions and other products

AER is a comparison tool, and it has limits worth knowing before you rely on it.

The first limit is charges. Lloyds states that AER accounts for compound interest "but it does not account for fees and charges"³. Halifax is more specific: "AER doesn't account for fees and charges for managing or accessing your savings"⁴, and Yorkshire Building Society says the same⁶. Two accounts quoting identical AERs can therefore leave you with different amounts if one charges for withdrawals or administration and the other does not. Charges are rare on mainstream savings accounts, but they exist, and the AER alone will not flag them.

The second limit is conditions. An AER says nothing about how accessible your money is, whether there is a minimum deposit, or whether the rate includes a temporary bonus that drops away after an introductory period. Mansfield Building Society's definition is typical of the standard wording: AER "illustrates what the interest rate would be if interest was paid and compounded once each year"¹⁹, and Principality uses the same formulation on its maturity accounts page²⁰. None of those definitions captures what you must do, or give up, to earn the rate.

The third limit is availability. Yorkshire Building Society notes that AER "isn't a feature with all investments or accounts, so you can't always use it"⁶. Halifax confirms that on savings accounts the rate is usually shown as AER²¹, but investment products quote returns differently, and a direct comparison between an AER and an investment's stated return is not comparing like with like.

In practice, the way around all three limits is to read the account's summary box and terms alongside the headline rate. The page on reading a savings summary box explains what each section tells you, and the guides to types of savings account, easy access accounts, notice accounts and fixed-rate bonds set out the conditions each type attaches to the rate.

Variable rates can go up or down

Most savings accounts pay a variable rate. StepChange defines it in one line: "An interest rate that can go up or down. The amount is decided by the lender"². Chip's glossary gives the saver's-eye view: if you open an account with a variable rate of 4% and the rate increases, "you will earn a higher return on your savings", and if it decreases, "your earnings will decrease as well"²².

Providers state this in their own terms. Virgin Money's E-Saver documentation says: "Rates are variable. This means we may increase or decrease interest rates at any time"²³, and Leeds Building Society uses almost identical wording for its online saver²⁴. Nationwide says of its FlexOne Saver that "the rates are variable. That means we can change them, up or down"²⁵. Which? summarises the position for easy access accounts generally: rates are variable, meaning they can go up or down at any time²⁶.

A variable rate is therefore a trade-off. Wollit's glossary notes that a variable rate "carries more risk than fixed rates", that "it may save money if rates fall", and that "it can make repayments unpredictable"²⁷. For a saver, the same logic runs in reverse: a variable rate can pay more if the market moves in your favour, but the provider can cut it, and the income is not guaranteed. Fixed-rate accounts remove that uncertainty for a set term, at the cost of locking the money away, a comparison covered in easy access vs fixed-rate savings.

What protects you is notice. Providers must tell you before a rate cut takes effect, though the period varies:

The pattern is that 14 days is common but not universal, and Monmouthshire's 30 days shows the range²⁸. Wollit makes the general point that "lenders usually provide notice, but the timing depends on the product terms"²⁷. The notice rule for your specific account is in its terms and conditions, and it is worth checking before you open it. The page on when a savings provider changes your rate covers what happens next, including your right to move the money.

One further wrinkle: some products cap how often the rate can move. nidirect's guidance on support for mortgage interest describes an Applicable Interest Rate that "can go up or down, but it won't change more than twice a year"³³. That is a government scheme rate rather than a commercial savings rate, but it illustrates that variability comes in degrees, and the terms will say if a rate is constrained.

Where help and protection come in

Understanding rates is the first step; knowing where the rules protect you is the second.

If a provider changes your variable rate, the notice periods in the table above are contractual rights, not courtesies. If a provider fails to follow its own terms, or you have a dispute about how interest was calculated or paid, you can complain to the provider first and then to the Financial Ombudsman Service, which is free to use. The page on consumer protection in UK financial services explains how that process works.

The money itself is protected separately. Deposits with UK-authorised banks and building societies are covered by the FSCS up to its statutory limit per person per firm, which matters if you are moving savings to chase a better rate. The page on how FSCS protection works for savings sets out the limit, and the narrower pages on joint accounts, temporary high balances and money above the FSCS limit cover the situations where the position is less straightforward.

On tax, the position depends on your circumstances, and free help is available. HMRC administers the allowances, and the pages on tax on savings interest, reclaiming tax paid on savings interest and tax for Scottish taxpayers explain the rules for each situation, since income tax on savings interest can differ for Scottish taxpayers.

Finally, if you are comparing accounts rather than checking one you hold, the rate is only one of several things to weigh: access, term, minimum deposit, bonus periods and protection all matter. The guides to how a savings account works, how to open a savings account, cooling-off periods and how to move savings to a new account cover the practical steps, and the savings section brings the whole subject together.