Protect your savings from rising inflation
Inflation hit 5.2% in September - its highest rate since 1992 - meaning savers face seeing the value of their nest eggs eroded.
Although inflation is now starting to slow, falling to 4.5% in October, it remains well above its 2% target. High inflation is bad news for consumers, as it has a corrosive impact on buying power. And for savers it means that every pound you put away will not go as far as it once did.
In order to beat rising inflation, savers must earn enough interest on their pennies so that, after tax, it is at least equal to inflation.
Currently, the Consumer Price Index (CPI) – which the government uses as the official measure of inflation – stands at 4.5%, while the Retail Price Index (RPI) – which includes mortgage repayments – stands at 4.7%.
Inflation - plus the fact that savings are taxed - mean it near impossible to earn interest on money at the moment.
Michelle Slade, analyst at Moneyfacts, warns that savers are going to struggle to find an account that beats inflation at the moment.
And Andrew Hagger, spokesman for Moneynet, says: “Consumers are suffering enough already as a result of the credit crunch and extremely tough economic climate, however they need to seek a decent home for their savings as well, otherwise their spending power will only be eroded further."
For the highest paying fixed and instant access saving accounts, read our daily round-up of the savings market.
Obviously, current interest rates on saving accounts will not protect your savings from inflation if you are a higher-rate taxpayer. But that doesn’t mean you have to sit back and watch your hard-earned, hard-saved money erode in value.
Mountford says the best option for most higher-rate taxpayers is to use their £3,600 ISA allowance, which will protect their savings from tax.
Although the ISA allowance is capped at £3,600, there are accounts on the market that allow transfers from previous years and still offer competitive rates.
To find the best ISA rates currently on the market, read our daily guide to the best fixed and variable ISAs on the market.
Higher inflation puts a new attraction on saving accounts that are linked to inflation.
This type of account promises to pay a set interest rate about the RPI.
According to Moneyfacts, there are currently four inflation-linked accounts on the market, two from the Leeds Building Society and two from National Savings & Investments (NS&I).
Leeds Building Society offers an Inflation Buster ISA and savings bond, that both pay 2.5% above RPI. However, bear in mind this is calculated on the rate on inflation on 30 April 2009 in year one and 30 April 2010 in year two.
It is hard to know how inflation will look in the future, and if the Monetary Policy Committee succeeds in its mission in bringing inflation down to 2% over the next two years then savers might find the interest rate they achieve doesn’t live up to their expectations.
NS&I offers two inflation-beating certificates, that both pay 1% above RPI with interest paid on maturity. The terms are either three-years or five-years.
Rachel Thrussell, head of savings at Moneyfacts, says these products do guarantee that your savings are not eroded by inflation. But she warns that if the certificate is repaid in the first year, then no interest or index linking is paid. If repaid after the first year, but before the end of the term, then a reduced rate is paid.
“Although these products may seem a good deal at the moment, rates at a much higher level can be found elsewhere. Before opting for any savings product, make sure you are getting the best rate of return from one that suits your needs,” Thrussell advises.
Kevin Mountford agrees that, while protecting your savings from the corrosive effects of inflation is a good idea, inflation-linked accounts are “gimmicky”.
“While some of NS&I’s products are good, there are better products out there rate-wise.”
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.