AER vs Gross Rate: What Savings Interest Rates Actually Mean

When comparing savings accounts in the United Kingdom, two interest rate figures appear repeatedly: the Gross Interest Rate and the Annual Equivalent Rate (AER). Both describe how much interest an account pays, but they do so in different ways and can produce different numbers for the same product. Understanding the distinction is essential for reading account advertisements accurately and comparing products on a like-for-like basis.

This article explains what each rate represents, how AER is calculated, when the two figures diverge, and how they interact with the UK tax framework for savings interest. It covers the regulatory and industry standards that govern how these rates are displayed, and addresses common points of confusion.

The Gross Interest Rate is the simple, flat rate of interest paid on a savings account before any taxes or charges, without accounting for the effect of compounding. The AER is a notional rate that illustrates what the gross interest rate would amount to if interest were paid and compounded once a year. Its purpose is to provide a standardised basis for comparison across accounts that pay interest at different frequencies.

If an account pays interest once a year, the AER and the gross rate are the same number. If an account pays interest more frequently than once a year — monthly or quarterly, for example — the AER will be higher than the gross rate, because each interest payment is itself earning interest during the remainder of the year. The more frequently interest is paid, the greater the gap between the two figures.

What the Gross Interest Rate represents

Gross interest is the interest earned on a savings account before taxes or charges. It is a simple, flat rate that does not take compounding into account. Since the introduction of the Personal Savings Allowance in April 2016, banks and building societies pay interest gross — that is, without deducting tax at source. The term "gross" therefore indicates that no tax has been automatically removed from the interest payment.

What the AER represents

The AER is a notional rate quoted in advertisements for interest-bearing accounts. Excluding any conditional bonus interest payable, it illustrates the effective annual rate of return that would apply if interest were paid and compounded once a year. The methodology is set out in the UK Finance and Building Societies Association Practice Note published in January 2025, which applies to all interest-bearing accounts maintained within the United Kingdom by banks and building societies, including current accounts that pay interest on credit balances.

The AER exists to solve a specific comparison problem. An account paying 5% with monthly interest payments will produce a slightly different return over a year than an account paying 5% with annual interest payments, because the monthly account allows earned interest to compound. The AER captures this difference in a single, standardised figure.

When the two rates are the same

If an account pays or credits interest once a year, the AER is equal to the gross rate. In this case, stating "5% gross/AER" is sufficient — both rates do not need to be quoted separately.

When the two rates differ

If an account pays interest more frequently than once a year, the AER is calculated by adding each interest payment to the deposit and calculating the next interest payment on the increased total. This compounding effect means the AER will always be higher than the gross rate for accounts that pay interest monthly, quarterly, or at any interval more frequent than annual.

A worked example from the UK Finance Practice Note illustrates this: a gross interest rate of 5% paid quarterly on a deposit of £100 produces quarterly interest payments of approximately £1.25, £1.26, £1.28, and £1.30, totalling £5.09 by year end. The AER for this account is therefore 5.09%.

The AER formula

For accounts where interest is paid more frequently than once a year, the AER is calculated using the formula:

AER = (1 + i/n)^n − 1

In this formula, i is the annual interest rate and n is the number of times per year that interest is paid.

For fixed-term accounts where the interest rate is quoted as a total payable over a period longer than one year, the formula is:

AER = (1 + r/100)^(1/m) − 1

Here, r is the total interest rate payable over m years. To illustrate: an account paying 5% in total over five years, with interest paid only at the end, produces an AER of 4.56%.

Underlying interest calculations may use actual/365 or actual/366 depending on the account, but for AER illustration purposes the divisor is 365 in all years. AERs are rounded and displayed to up to two decimal places.

Advertising requirements

Advertisements that quote a rate of interest must quote the AER alongside either the gross interest rate or, for Cash ISAs, the tax-free rate. No rate or return may be given greater prominence than the AER. For Cash ISAs, the AER and the tax-free rate should be used rather than the gross rate.

Where an advertisement includes a conditional bonus rate, the AER inclusive of that bonus can only appear if the AER without the bonus is also quoted and given the same prominence. The AER including the bonus must be clearly identified as such.

These requirements are set out in the UK Finance and Building Societies Association Practice Note of January 2025, which replaced the previous Code of Conduct for the Advertising of Interest Bearing Accounts that had been in place between 1985 and 2024. The Financial Conduct Authority monitors compliance through BCOBS and its financial promotion rules. The Practice Note itself is described as being for guidance only, with banks and building societies free to reach their own conclusions on interpretation.

Summary box requirements

Under FCA Handbook rule BCOBS 2.2A.1R, firms must ensure that a direct offer financial promotion relating to a savings account includes a summary box. The summary box must contain the interest rate, whether the firm can change it, estimated balance projections, how to open and manage the account, and withdrawal terms. The information must be presented in clear, easily understandable language and in a prominent way. Where more than one rate of interest may apply, each rate must be shown with equal prominence.

Personal Savings Allowance thresholds (2025/26 tax year)

Since April 2016, banks and building societies have paid interest without deducting tax at source. Whether tax is owed on savings interest depends on the saver's income tax band:

• Basic rate taxpayers (20%) can earn up to £1,000 in savings interest tax-free per tax year.
• Higher rate taxpayers (40%) can earn up to £500 tax-free per tax year.
• Additional rate taxpayers (45% and above) receive no Personal Savings Allowance.

These figures are confirmed for the 2025/26 tax year, which runs from 6 April to 5 April. Interest from ISAs does not count towards the Personal Savings Allowance.

Starting rate for savings

Individuals with low other income may be able to receive up to £5,000 of savings interest tax-free under the starting rate for savings. This allowance is reduced by £1 for every £1 of other income above the Personal Allowance of £12,570, and is not available where other income is £17,570 or more. The starting rate for savings can be combined with the Personal Savings Allowance.

Tax reporting

Banks and building societies report all interest paid to HMRC at the end of each tax year. For individuals who are employed or receiving a pension, HMRC may adjust the tax code to collect any tax due automatically.

Assuming the gross rate is the "real" rate

It is natural to look at the gross rate as the straightforward figure and to treat the AER as an artificial calculation. In practice, the AER provides a more accurate picture of the return an account delivers over a year, because it accounts for the effect of compounding. Two accounts with identical gross rates but different payment frequencies will produce different actual returns, and the AER reflects that difference.

Thinking a higher gross rate always means a better return

An account advertising a higher gross rate does not necessarily deliver more interest than one with a lower gross rate, if the payment frequencies differ. The AER is the figure designed to allow direct comparison between accounts, regardless of how often they pay interest.

Confusing gross rate with the rate before tax

Before April 2016, banks and building societies typically deducted basic rate tax from interest before paying it. Since the introduction of the Personal Savings Allowance, interest has been paid gross — that is, without tax deducted at source. The term "gross" now simply means the flat rate before compounding and before any tax considerations. Tax may still be owed depending on the saver's total interest income and tax band, but this is handled separately through the self-assessment or PAYE system rather than by the bank at the point of payment.

Overlooking how conditional bonuses affect the AER

Some accounts offer a conditional bonus — for example, an additional rate payable if no withdrawals are made within a set period. When an advertisement shows an AER that includes a conditional bonus, it must also show the AER without the bonus at the same prominence. This distinction can be easy to miss, and the headline AER may not reflect the return that all account holders actually receive.

Misreading regular savings account rates

For regular monthly savings products with a limited life of one year where interest is credited only once at maturity, the AER is deemed to be the same as the nominal rate. This means the advertised rate for a regular saver may appear to offer a higher return than is achieved in practice, since deposits are built up gradually over the year rather than invested as a lump sum from the outset.

Accounts paying interest annually

Where an account pays or credits interest once a year, the AER equals the gross rate. These can be combined in a single statement — for example, "5% gross/AER" — without quoting each separately.

Cash ISAs

For Cash ISAs, advertisements use the AER and the tax-free rate rather than the gross rate. ISAs have a separate annual subscription limit (£20,000 for 2025/26). Interest earned within an ISA does not count towards the Personal Savings Allowance.

Tiered interest rates

Where an account offers tiered interest rates — different rates depending on the balance — the appropriate rate is used as the balance builds up in AER calculations. The summary box must show each rate with equal prominence.

Variable rate accounts

AER calculations for variable rate accounts do not make allowance for changes that may occur because market rates move up or down. The only rate changes taken into account are those stated at the outset. If an account has a rate that increases the longer a deposit is held, the higher rate is used after the relevant period in the calculation.

Time-limited offers

Where the AER varies according to the date of deposit — such as an unconditional bonus available until a fixed calendar date — all advertising must include a statement that the AER assumes investment was made on a specified date. That specified date should be relevant to when the advertisement appears and not more than one month away. Advertisements showing a recalculated AER must be amended monthly unless the recalculated AER would be higher than originally advertised.

Credit unions

Certain BCOBS provisions do not apply to credit unions, including BCOBS 2.2A (the summary box requirement) and several other specific rules. Credit unions have separate regulatory requirements under different legislation.

Joint accounts

For joint savings accounts, interest is usually split equally between account holders for tax purposes. Each person's share of the interest counts towards their individual Personal Savings Allowance.

When reading a savings account advertisement, the AER is the figure designed for comparison. It shows the effective annual return with compounding taken into account, making it possible to compare accounts that pay interest at different intervals on a consistent basis. The gross rate shows the simple, flat rate before compounding.

For accounts that pay interest annually, the two figures are identical and the distinction is academic. The difference becomes relevant for accounts paying interest monthly, quarterly, or at other sub-annual intervals, where the compounding effect means the actual return over a year is slightly higher than the gross rate alone would suggest.

Neither figure accounts for tax. Whether any tax is owed on savings interest depends on the saver's overall income and tax band, assessed through the Personal Savings Allowance framework. Banks and building societies pay interest gross and report it to HMRC annually.

The AER also does not capture every feature of an account. Conditional bonuses, withdrawal restrictions, tiered rates, and other terms and conditions all affect the actual return. The advertising rules require that conditional bonus rates be shown alongside the non-bonus AER at equal prominence, but the full terms of any account extend beyond the headline rate figures.

If the AER and gross rate are both shown, which one should be used for comparison?

The AER is the figure designed for comparing accounts on a like-for-like basis. It accounts for differences in how frequently interest is paid and compounded.

Why is the AER sometimes higher than the gross rate?

When interest is paid more frequently than once a year, each payment is added to the balance before the next payment is calculated. This compounding effect means the total interest earned over a year is slightly more than the gross rate alone would produce. The AER reflects this higher effective return.

Are there accounts where the AER and gross rate are always the same?

If an account pays or credits interest once a year, the AER equals the gross rate. For regular monthly savings products with a one-year term where interest is credited only at maturity, the AER is also deemed to be the same as the nominal rate.

Does the AER include conditional bonus interest?

Not by default. The standard AER figure excludes conditional bonus interest. An AER that includes a conditional bonus may be shown in advertisements, but only if the AER without the bonus is also quoted at the same level of prominence.

Is tax deducted from the gross rate?

Since April 2016, banks and building societies have paid interest gross, without deducting tax at source. Whether tax is owed depends on the saver's income tax band and total savings interest, assessed through the Personal Savings Allowance. Basic rate taxpayers can earn up to £1,000 in savings interest tax-free per year, higher rate taxpayers up to £500, and additional rate taxpayers receive no allowance. These thresholds are confirmed for the 2025/26 tax year.

Does ISA interest count towards the Personal Savings Allowance?

Interest earned within an ISA does not count towards the Personal Savings Allowance. For Cash ISAs, advertisements use the AER and the tax-free rate rather than the gross rate.

How is interest taxed in a joint account?

For joint savings accounts, interest is usually split equally between account holders for tax purposes. Each person's share counts towards their individual Personal Savings Allowance.

Who sets the rules on how AER is displayed?

The UK Finance and Building Societies Association Practice Note, published in January 2025, sets out the methodology and advertising guidance for AER. The Financial Conduct Authority monitors compliance through BCOBS and its financial promotion rules. The Practice Note is described as guidance, with banks and building societies free to reach their own conclusions on interpretation.

Do credit unions follow the same rules?

Certain BCOBS provisions, including the summary box requirement under BCOBS 2.2A, do not apply to credit unions. Credit unions operate under separate regulatory requirements.

• Gross Rate is the flat interest rate before compounding and tax.
• AER standardises rates to a "compounded annually" figure for easy comparison.
• Compounding effect: Monthly/quarterly interest payments make the AER higher than the gross rate.
• Advertising rules: AER must be the prominent figure. Conditional bonuses must not hide the base AER.
• Tax status: Interest is paid gross (no tax deducted at source). Personal Savings Allowance determines tax liability.
• Calculation: Uses a 365-day basis for AER standardisation.

Related: Savings Interest Pushed You Into Higher-Rate Tax? | Breaking a Fixed-Rate Bond Early.