Posted on June 19th, 2013 | Categories - Savings
The news yesterday that the rate of inflation rose in May heaped more misery on struggling savers, most of whom will now find it impossible to get a real return on their savings.
Figures from the Office for National Statistics (ONS), show the Consumer Prices Index (CPI) rose to 2.7% in May, up from 2.4% in April.
The rise was in line with predictions from experts, with the Bank of England also suggesting that inflation could hit 3% before the end of the year.
At the same time, RPI (Retail Prices Index), which is used to calculate increases to many state benefits, rose by 0.2% to 3.1% in April.
Why do savers need to beat inflation?
The answer to this question really is very simple. If the rate of inflation exceeds the interest paid on a savings account, then the buying power of the money in the account is reduced in real terms.
Take an example of a saver who has £50,000 in a one year fixed rate bond paying 2%. When the bond matures the value will be £52,000, but if inflation averages say 3% during the year, just 1% above the rate of interest, then the buying power of that cash plummets to less than £50,000.
Remember too that it is the net rate, after tax has been deducted, which has to be better than inflation. So, what rate of interest do you need to beat inflation?
- 0% tax payer or Cash ISA saver: 2.70%
- 20% taxpayer: 3.375%
- 40% taxpayer: 4.50%
- 45% taxpayer: 5.40%
Inflation really is the hidden danger for savers. Your statement shows the value of the capital is increasing, but in actual fact you can buy less with the money. Perhaps statements should show the value effect of inflation on your savings? We can’t see banks and building societies agreeing to that!
What options do savers have to beat inflation?
Frankly they are very limited, which is probably being kind, in reality they are almost non-existent.
If you only consider savings accounts which accept a lump sum deposit, rather than monthly payments, then there are no accounts whatsoever which pay savers who are basic or higher rate taxpayers enough to beat inflation.
If you are a non-taxpayer, you can just about beat inflation with the fixed rate bonds from the Bank of London & the Middle East, although the minimum deposit is relatively high. If you are prepared to tie up your savings for a long period the five year fixed rate bond from the Punjab National Bank would also do the job, with a more accessible minimum deposit of just £500.
Cash ISA (Individual Savings Account) investors fair little better.
The only options are First Direct’s Instant Access Cash ISA, which pays 2.96% on balances above £40,000; making it a viable option for transfers only.
What should savers do?
Savers have been hit from both sides, inflation has risen and the Funding for Lending scheme has slashed interest rates.
Neither problem is expected to disappear soon.The Bank of England has predicted inflation will stay above the 2% target until 2016 and the Funding for Lending scheme has recently been renewed.
Our view is that enough is enough; it’s time for the Bank of England and the government to consider the plight of savers. Especially in light of warnings, most recently by the Building Societies Association (BSA), that we are in danger of creating another housing bubble.
Do we expect anyone to listen to us? Frankly no, so here are a few tips for savers to help you ride out the storm.
Use Cash ISAs. The less tax you pay, the more interest you retain and the closer you to inflation you can get.
Reduce tax. If you are in a couple hold the savings in the name of the lowest rate taxpayer. This will help to reduce the tax you pay and again take the interest rate that bit closer to inflation.
Work your savings hard. Shop around, take advantage of bonus rates, and scour the best buy savings accounts. You probably won’t match inflation but again you will get closer and limit the damage.
Consider peer to peer lending. This option is rising in popularity; although it is certainly more risky than a traditional savings account as there is no Financial Services Compensation Scheme (FSCS) protection.
Consider investing. Historically shares have outperformed cash, but you have got to be prepared for the rollercoaster ride you might get.
Whilst this is definitely an option, you have to be prepared to accept the risk that the value of your savings could fall. If you are considering this as an alternative and are inexperienced then take advice.
Take action, inflation is costing you money
Work your savings hard, consider other options, invest some time and take advice. Whatever you do though, take action; otherwise you’ll have a shock when you come to spend your hard won savings.