We all know that savers are finding it tough at the moment, but if you have money in Cash ISAs or savings accounts this week was a particularly bad one for you, with two pieces of news showing just hard things have become.
Firstly, whilst it was hardly a surprise when the Bank of England announced base rate would stay at 0.5% for yet another month, the Bank also issued a statement in which they admitted that inflation is likely to rise in months.
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Inflation, which reduces the buying power of capital and is the enemy of all savers, many of whom are pensioners with fixed incomes, meaning they are being attacked by inflation on two fronts.
Secondly, new research has shown interest rates on Cash ISAs have fallen to new lows. This time last year the average interest rate on a Cash ISA, according to Moneyfacts, was 2.55%, since the introduction of the Funding for Lending Scheme this has fallen to 1.74%.
Amazingly there is now only one Cash ISA, from the Coventry Building Society, offering an above inflation interest rate; and this probably won’t be around for much longer.
Savers, many of who are retired or close to retiring, really are under fire from all angles at the moment. Interest rates are falling across the board, inflation is relatively high especially for older generations and Annuity rates have fallen off a cliff.
No wonder many savers are jealously looking at the help given to those people who want to borrow money!
So if you are a saver, what are your options? How can you stop your savings being eroded by inflation? How do you improve your return?
Sit it out and be flexible
If you are prepared to be patient, and you will probably need to be very patient, you could just sit out the storm and wait for things to improve.
The current ‘perfect storm’ of ultra-low interest rates and rising inflation cannot last forever; the Bank of England continues to predict that inflation will eventually move back to the 2% target, the Funding for Lending Scheme won’t last for ever and nor will a 0.5% base rate.
But no one is predicting a change anytime soon.
If you decide to sit it out flexibility is everything, locking money away in a long term fixed rate would stop you from taking advantage of any future interest rate rises. You should consider shorter term deals, probably up to a maximum of two years, perhaps even less, so you can pounce when rates do eventually rise.
Consider investing
Savers traditionally do not want to see their capital fall in value, although of course this increases the chances of inflation eroding the value of their capital over time.
Investors on the other hand are prepared to accept fluctuations in the value of their capital, hoping that the increased risk they are taking will be rewarded with a higher return.
As a saver one option is to consider crossing the line and invest rather than save. This would of course involve taking more risk; with talk of a ‘bond bubble’ and the FTSE at a relatively high point if you decide to change strategy you would need to make your decisions carefully.
Remember the basic savings rules
With interest rates falling so quickly now is the perfect time to remember some of the basic savings rules.
Firstly, always shop around for the best savings interest rates, secondly check old savings accounts and find out whether the interest rate has been cut, if it has, look for a better deal. Finally, take advantage of bonus interest rates, just remember when they come to an end and then look for alternatives.
In these times of low interest rates you will have to work your savings hard if you are to minimise the effects of inflation; that means using all the weapons at your disposal and also investing time and effort.
Reduce tax
The less tax you pay on your savings the better the return will be and the closer you will get to inflation.
Unfortunately the tax-free savings options are limited, obviously you should use your Cash ISA (Individual Savings Account) allowance each year and if you are saving for your children consider using a Junior ISA.
Where next? The choices are minimal; if you are a higher rate tax-payer you could consider Premium Bonds, which provide a tax free return, you could also consider using a pension. Pension contributions qualify for tax relief and if you use a SIPP (Self-Invested Personal Pension) and open a deposit account for the SIPP the interest you receive will be tax free. Remember though, once your money is in a pension it can’t come out until you are at least 55 and even then only 25% can be taken as a tax-free lump sum, with the balance only available to provide you with an income.
Buy a Purchase Life Annuity?
If you need your savings, or indeed the tax-free lump sum from your pension at retirement, to provide you with an income, you could consider a more drastic solution and buy a Purchase Life Annuity (PLA).
Annuity rates have fallen dramatically over recent years, but the return is still better than you would get from a long term fixed rate savings account and because of the way a PLA is taxed, basic rate and higher rate tax-payers should end up with a higher, after tax income, than they would from a savings account.
Of course there are downsides, you will give up access to your capital, you need to be in your mid 50’s or older, and you may die before you have had more back from the Annuity than you have paid in. However, PLAs are becoming an increasingly popular option, especially for retirees who use their tax-free lump sum in this way.
Consider a buy to let property
If you are looking for income and have a lump sum to invest why not consider becoming a landlord?
With house prices down by around 20% since the financial crisis, no meaningful rise since then and a buoyant rental market, now is perhaps the time to consider investing in property.
There are of course huge downsides, property values could fall further, if you choose the wrong flat or house it might be hard to find a tenant and there are always unexpected costs. But for some people buying a property might offer an attractive alternative to the poor interest rates currently available from savings accounts.
Get used to low interest rates
With inflation expected to rise, the Funding for Lending Scheme is here to stay, most banks and building societies having repaired their balance sheets and mortgage lending relatively flat, we can expect savings interest rates to stay below the rate of inflation for months and perhaps even years to come.
To get a return anywhere close to inflation savers will need to be flexible, consider other options, and working their capital hard.
Our team of Independent Financial Advisers in Nottingham are experienced in advising people on their cash and savings options, if you would like advice on your options call one of our IFAs today on 0115 933 8433, alternatively enquire online or email info@investmentsense.co.uk
