The Annual Equivalent Rate (AER) is designed to make savings accounts easier to compare. The AER assumes that you keep your money in a particular savings account for a year, while taking more factors into account than the gross rate, which means it can show a truer picture.
The main difference is that gross rates don't take compound interest into account (where you earn interest on your initial investment plus any interest you've previously accumulated). So, if you earn your savings interest monthly, for instance, this is going to result in a higher AER than gross rate (although if you earn your interest annually, the AER and gross rate may well be the same).
As the AER takes into account the interest you would earn for having your savings in an account for a full year, the other factor that affects it is bonuses. A savings account may have an introductory bonus that forms a portion of the interest rate you receive. When this introductory bonus applies for less than a year, the AER uses the interest you would earn with the bonus, as well as the interest you'd earn once the bonus finishes over the year, to arrive at a truer annual rate.
As a general rule of thumb, you can compare AERs on savings accounts to see which would earn you the most interest if you intend to keep your money in the account for a full year.
However, the Annual Equivalent Rate does not take into consideration any tax you may have to pay on your savings interest, so if you earn more than £1,000 in interest (for basic rate taxpayers) or £500 (for higher rate taxpayers), you wouldn’t be able to compare an AER on a traditional savings account with an AER on a cash ISA, where the interest you earn is all tax-free.
Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.