The Bank of England recently announced that RPI (Retail Price Index) has risen to 3.7%, this is a sharp rise on previous months and causes a problem for savers, where do you get a real, above inflation return on your savings?
When tax is taken into account the rate of return needed is even higher, if you are a basic rate tax payer at 20% a gross return of 4.63% is needed just to keep pace with inflation, a 40% tax payer needs 6.17% and once the new 50% rate is brought in those paying the highest level of income tax need a massive 7.4% return on their savings, just to preserve their value.
The first port of call when looking to get a rate to match or better inflation is to consider your tax free options, for most these are limited to Individual Savings Accounts (ISAs) and the tax free National Savings & Investments (NS & I) products.
There are no Instant Access Cash ISAs that accept a lump sum and pay a rate of interest above the rate of RPI, to get a an inflation beating rate you need to tie your money up for at least three years. Stroud & Swindon are currently offering 5% if you are prepared to tie up your savings for three years and Yorkshire Bank are offering the same rate for five years.
When it comes to NS & I products the Index Linked Savings Certificates stand out as a possible solution to the problem. Both the three and five year certificates pay 1% above inflation and have a low minimum starting balance of just £100. The interest is tax free and these plans certainly help to outstrip inflation, unfortunately the maximum that can be held in is £15,000 in each.
Once these tax free options are exhausted it is then harder for tax payers to find a real return, and to do so savings certainly need to be tied up.
For those basic rate tax payers looking for the required return of above 4.63% savings need to be tied up for a minimum of three years and even then the rate is not quite enough to beat inflation. ICICI bank pay 4.6% on their HiSave Fixed Rate Account or for a four year fixed rate the Stroud & Swindon’s Fixed rate Bond Issue 85 will pay 4.6%.
The rates on offer exceed 5% gross if you are prepared to tie up your savings for five years, with Northern Rock and Yorkshire Bank leading the way with accounts paying 5.5% and 5.65% respectively.
The fact that savings need to be tied up for a considerable period of time to get a return that beats inflation leads to a further dilemma. Bank Base Rate is at an all time low, if it rises, will this be passed on to savers? And will those that have locked into a three, four or five year account be left getting a lower interest rate than others who waited for rates to rise? It is far from certain rates will rise in the short term, however moving into 2011 many economists believe that they will rise.
For 40% tax payers and those that will pay 50% from the start of the new tax year, the picture is far from rosy. Other than the tax free options there are no accounts that pay the rates required to provide an after tax return that beats inflation, for those people unless you are prepared to inject some risk into your savings with the hoper of achieving a better return, there is little choice but to accept that inflation will erode savings at least in the short term.
If you believe the Bank of England though there is some good news on the horizon, they believe that the rise in inflation is only a spike, due to the increase in VAT in January, and that the rate will fall during the year. Others are more pessimistic however and believe that the effects of the Bank’s policy of Quantative Easing (QE) will be inflationary and cause this spike to turn into a protracted period of inflation.
Only time will tell who is right, one thing is for certain though; you have got to make your money work even harder for you more now than ever before if you want it to maintain its buying power.
Investment Sense is here to help you and your savings work harder, our best buy tables are updated regularly and show the most competitive rates of interest for different types of accounts. We also offer a free Cash Management Service which takes the hard work out of finding the best rates for your savings.