Friday, May 14

Interest rate puzzle

I have a savings account with ING Direct. When I was checking my account balance recently, I was surprised to see that their interest rate for an ordinary savings account was much lower than their interest rate for a tax-free savings account. Currently, their standard savings account pays 1.2%, while their tax-free account pays two-thirds more: 2%.

I found this baffling. In both cases, an investor puts their money into an account, and ING lends it out to borrowers at a higher rate in the form of mortgages. Whether or not the investor is charged tax by the government shouldn't affect ING's, so I was wondering why the accounts had different rates.

To satisfy my curiosity, I emailed ING to ask them why their accounts have different rates. Here's the response I got:
"Yes, there is a difference between the Investment Savings Account (ISA) and Tax-Free Savings Account (TFSA) interest rates. These accounts do operate differently and serve different savings goals.
Our ISA has a current interest rate of 1.20%. There are no minimum balance requirements to maintain your account. And we don't charge fees or service charges. You can deposit up to $5,000,000 into an ISA, so our Savers tend to save for bigger savings goals in this account (i.e. home purchase).
The TFSA is a government-registered account. The maximum contribution per year, starting in 2009, is $5,000 towards your TFSA. Any withdrawals made in one year can only be re-contributed in the following year, along with any unused contribution amount. 
Because these accounts are two separate products, the rates are not tied to each other either."
But the response still doesn't seem to clear things up. If people with the investment savings account tend to save for longer-term goals with higher deposits, one would think ING would be willing to pay more for these types of savings. Higher levels of saving and fewer withdrawals means ING can feel safer lending out the money for longer periods of time because there's less chance it'll get withdrawn.

Can anyone think of possible explanations of why banks might offer higher rates on tax-free savings accounts than ordinary ones?