Can Santander's 123 current account beat an ISA?

santander bank branch©

SINCE the current account Switch Guarantee was launched in 2013, Santander and Halifax have been winning the most customers, according to figures from the Payments Council.

The main reason, in Santander's case, has been their 123 current account: at one point, nine out of 10 people who switched were signing up to it.

With the official tax-free saving products offering rates that continue to look rather flat, high interest current accounts have become a surprisingly viable saving option.

The big attraction for the 123 current account was the tiered interest, offering 1% on balances of at least £1,000, up to 3% on savings of more than £3,000 - far more than the current crop of easy access ISAs offered.

But Santander's 123 products have been victims of their own success, and the famous tiered returns have just been replaced by one flat rate of interest.

Is it enough to maintain the account's reputation as an ISA beating product?

More interest than an ISA?

As mentioned, interest earned on the account depends on the balance. From launch until the end of October this year, savings of more than £1,000 earned 1% interest; balances between £2,000 and £3,000 earned 2%; accounts containing more than £3,000 earned 3%.

However, from November 1st 2016, that changed, to a flat rate of 1.5% AER on all positive balances

ISAs in focus
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May 2016: Lifetime ISAs announced

Interest is still payable up to a maximum balance of £20,000 - almost £5,000 more than the current yearly cash ISA limit of £15,240.

Previously someone with an average balance of £20,000 would have been able to earn £600 in interest over the year; now they'll earn £300 per year.

But the cap on an ISA resets each tax year: every year the ISA is open, holders can invest up to the maximum allowance again all over again, and interest will be earned tax free on the total amount.

Not so with the 123 current account; the cap applies to the total balance. The table below shows interest earned with different levels of credit balance.

Average credit balance £500 £1,000 £2,000 £3,000 £20,000 £40,000
Interest rate 1.5% AER 1.5% AER on £20k
Interest earned £7.50 (<£1 monthly) £15 a year (<£1 monthly) £20 a year (£1.50 monthly) £45 a year (£3.75 monthly) £300 a year (£25 monthly) £300 a year (£25 monthly)

Prior to April 2016, we didn't see the full benefit of all the interest we were earning, however, as it was taxed before we received it.

Now, however, basic rate tax payers can earn up to £1,000 interest per year before having to pay tax on that money - and as it's only possible to earn £600 in interest with the 123 account, that means many savers will pocket the lot.

Higher rate taxpayers (those earning more than £42,700 in the 2016 tax year) may still be affected, as they can only earn £500 in interest before having to pay tax.

By comparison, the highest earning ISAs for 2016/2017 offer just 1.16% for an easy access account, and 1.4% fixed for two years, or 1.9% fixed for five years - and the latter two require minimum balances of £5,000.

Depending on the level of savings therefore, the 123 current account has the potential to earn significantly more interest over the year, and for many it won't be liable for tax.

Spend money, get some back

With the loss of the tiered interest rates, the only part of the account that reflects its name is the cash back on offer. Santander offer 1%, 2% or 3% cash back on household bills - but there a few, fairly straightforward, caveats.

  • 1% cashback on water, council tax and Santander mortgage payments (£1,000 max mortgage payment)
  • 2% cashback on gas and electricity bills
  • 3% cashback on mobile, home phone, broadband and paid for TV packages

Firstly, there's a monthly £5 fee for holding the account, which is automatically deducted each month whether or not the account qualifies for cash back.

Secondly, at least £500 must be deposited into the account each month - excluding internal transfers.

Account holders must also set up at least two direct debits; the cash back is applied only to payments made through direct debits.

Household bills that may qualify include electricity, gas, council tax, water, mobile and landline phones, broadband, paid for TV packages and Santander mortgage payments.

Cash back from whom?

Santander have this handy tool to check if a company is included in the cash back deal.

Different levels of reward apply depending on how Santander categorise a company.

Broadly, water and council tax qualify for 1% cash back; payments to gas and electricity companies will net 2%, and there's 3% for paying telecoms companies by direct debit.

People with mortgages from Santander and the old Alliance & Leicester building society also qualify for cash back at a rate of 1%, but only on the first £1,000 of each monthly payment - equivalent to up to £10 per month.

A selection of the companies involved is shown below. If a supplier isn't on the list yet, Santander say they're open to suggestion and recommend popping into a branch or contacting them online to request the addition.

Water Gas and electricity Telecoms Mortgages Council Tax
1% cashback 2% cashback 3% cashback 1% cashback 1% cashback
Anglian British Gas BT Santander All UK councils
Severn Trent EDF Energy EE Alliance & Leicester All Northern Ireland rate payments
Southern E.On O2
Thames Npower Sky
United Utilities Southern Electric Gas Three
Wessex SSE Virgin Media
Yorkshire SWALEC Gas Vodafone

Encouraged to save and spend

The monthly fee for holding the account should be covered as long as customers remember to set up direct debits to pay a couple of household bills each month.

But while there are plenty of benefits for savers and those using it to run their household, people who need an overdraft more than very occasionally should be wary.

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Those using an unauthorised overdraft or going over their agreed limit will incur a charge of £6 per day, up to a maximum of £95 per month.

At present, an arranged over draft will cost £1 a day every day we use it. From January 9th 2017, it'll cost between £1 and £3 every day depending on how much in debt we are:

Authorised overdraft balance Charge
Below £2,000£1 a day
£2,000 to £2,999.99£2 a day
£3,000 and above£3 a day

Like several other banks, Santander offer a buffer before charging overdraft fees of either sort - theirs is set at £12. They also give people up to 4pm on the day they go overdrawn to get money into the account before applying any charges.

Unlike some banks, Santander don't charge transaction fees for payments attempted when an account is in unauthorised overdraft, regardless of whether the payment is successful or not.

However, they will charge an overdraft fee if going into the red is the result of them taking the monthly account fee.

As with most UK current accounts, there are additional charges when using a card abroad. Cash withdrawals will be subject to a charge of at least 1.5% or £1.99; spending on the card will incur a charge of £1.25 per transaction. Both are subject to currency conversion fees of 2.75%.

But reflecting where the bank's headquarters are, people with the 123 account (and any others who deposit at least £500 in their accounts each month) will be able to withdraw cash from ATMs in Spain fee-free.

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