Inflation continues to remain stubbornly above the Bank of England’s target, CPI (Consumer Price Index) sat at 3.1% last month and RPI (Retail Price Index) is even higher at 4.6%.
Since the turn of the millennium CPI has been relatively steady, only once, in September 2008 has it exceeded 5%.
So with CPI at 3.1%, what’s the problem?
Well, the table below which compares CPI and Bank Base Rate demonstrates the main issue.
|Month & Year||CPI||Bank of England Base Rate|
The Bank of England, along with other central banks, reduced their interest rates to try and stimulate economic growth, and for a prolonged period we have seen the Bank of England Base rate below the level of inflation.
In previous years, the reverse has been true; interest rates have exceeded inflation, preserving the buying power of savings. This is not necessarily the case anymore, which is why savers have to make their money work harder for them, just to maintain its real value.
But I don’t get 0.5% on my savings, I get more, I hear you say
That’s true, banks and building societies pay more interest than just matching Bank of England base rate, however, it’s not that simple, you need to take tax into account.
So, how can my savings keep pace with inflation?
We thought we would take a look at whether your cash savings could get sufficient interest to beat inflation.
We have used CPI as our measure for the purposes of our research.
If you are interested in finding out more about one of the accounts mentioned, simply click on the name of the bank or building society to be taken to a page with further details.
Where to start? Well, to begin with, most people will use their Cash ISA allowance (£5,100 in 2010/11), which makes perfect sense as the interest is tax free of course.
The first thing to bear in mind is that interest rates in Cash ISAs are generally slightly lower than a comparable non ISA account, however, for both basic and higher rate taxpayers, the tax free interest means they are still worthwhile.
To get a return from a Cash ISA that beats inflation, you will need to tie your money up for at least 45 days and then have an existing balance to transfer of at least £35,000; this account is offered by the National Counties Building Society and offers an interest rate of 3.10%.
But what if you want to start a new ISA and have more modest savings, you will still need to tie up your money for at least two years, as the following table shows.
|Bank or Building Society||Name of account||AER||Notice Period||Minimum deposit|
|Bank of Cyprus||Cash ISA Bond 20th Issue||3.60%||2 years||£1|
|Bank of Cyprus||Cash ISA Bond 21st Issue||4.15%||3 years||£1|
|Halifax||Fixed Rate ISA Saver||4.25%||4 years||£500|
So, you’ve used up your ISA allowances, where do you look to now?
The first thing you need to do is calculate the gross rate of interest, taking into account your tax status, that you need to get so that the net rate matches inflation. The following table shows the gross rate needed for the three tax bands.
|Tax band||Gross interest rate needed|
For a 20% tax payer to beat inflation, savings would have to be tied up for at least three years, no other accounts with shorter notice or fixed rate periods offer interest rates sufficient to combat the effects of inflation and the tax payable.
Click here to see the three year fixed rate selection, which offers inflation beating rates for basic rate taxpayers.
The news is not so good for higher rate tax payers; there are currently no accounts that offer a net interest rate which beats inflation.
The conclusions are clear:
- A Cash ISA can help beat inflation, but only if you are prepared to tie up your savings for a period of time
- A basic rate tax payer can find accounts which offer a net interest rate to beat inflation, however again the money has to be tied up for a period of time
- There are no accounts, other than Cash ISAs, which a higher rate tax payer can use to beat inflation
So, how can a higher rate taxpayer beat inflation?
It would be fair to say that the options are limited.
Firstly, use a Cash ISA, many people overlook these as the allowance is small (£5,100 in 2010/11), however, over time they can build to significant sums and the Government have indicated that they intend to increase the maximum annual subscription in line with inflation.
Secondly, look out for accounts that offer to match inflation. National Savings & Investments (NS&I) Index Linked Certificates used to pay RPI + 1% and the returns were tax free. Unsurprisingly this year they have been extremely popular and were withdrawn as a result. We hope these will be relaunched, albeit probably in a different format, but nevertheless they could be a useful method of keeping pace with inflation.
The National Counties Building Society (NCBS) also offer inflation beating accounts from time to time. However, these tend to be launched and withdrawn very quickly, so keep your eye out for them, we will always alert you on our website to any new launch they offer.
You should also make sure that your savings are held in the most tax efficient way, if you are a 40% or 50% tax payer and your partner pays a lower rate, then move savings into their name to benefit from a reduced rate of tax on the interest.
Finally, you could look to Deposit based Structured Products, however over recent months the projected returns from these have fallen, as the yields on fixed interest assets have reduced. More information about Deposit based Structured Products can be found here.
So what are your other options?
So far we have discussed only deposit based investments. If these are held correctly, with no more than the current FSCS limit held with one provider, the capital is secure. However, as we have clearly demonstrated you are introducing inflation risk to your savings.
One way to try and get a return above inflation would be to introduce some risk to your savings and investments by considering other asset classes such as fixed interest assets, commercial property and equities. Clearly there is no guarantee that these asset classes will produce a return above inflation and your capital would be at risk; however, that may be the price you have to pay in these times of relatively high inflation.
Our advisers are experts in making your money work harder for you and will spend time working with you to identify your goals, the risk you wish to take, and then recommend suitable investments that will match both. They don’t leave it there either, reviewing any investment is key to its success and that’s exactly what they do.
Click here to meet the team and feel free to get in touch to chat through your requirements.