More misery for savers
The cost of living may be coming down but with inflation still well above target, savers continue to suffer from poor returns on their nest-eggs.
The Consumer Prices Index (CPI) – the official measure of inflation – fell to to 3.1% in December, down 100 basis points from 4.1% in November. Meanwhile, the Retail Prices Index (RPI) – which includes mortgage interest payments – also plummeted by 2.1% in December to 0.9%.
The Bank of England’s inflation target is 2%, and whenever the CPI is more than 100 basis points above or below this figure its governor, Mervyn King, is required to write to the Treasury explaining why. Inflation rose throughout most of 2008, peaking at 5.2% in September, as a result of high food prices and record crude oil costs, which fed through to petrol and energy bills.
Now that the cost of oil has fallen, inflation has started to come down, spurred on by discounts in the shops and December’s VAT cut. Experts now largely expect inflation to continue to fall, eventually turning negative by the summer.
However, for savers, high inflation remains a pressing concern as it erodes the value of their nest-eggs. The fact that Bank of England interest rates are at historically low levels (1.5% in January) is also eating into returns, and making competitive savings accounts a thing of the past.
David Black, banking consultant at data provider Defaqto, says: “The dramatic falls in the Bank of England base rate have meant that savers are facing really bleak times and many taxpayers now have few opportunities to obtain a real rate of return after inflation and tax are taken into account.”
Black estimates that a higher-rate taxpayer now needs to earn 5.17% just to keep pace with inflation whereas a basic-rate taxpayer requires 3.88%.
Recent figures from the Bank of England revealed that the average interest rate on no-notice accounts was under 1% in December and some savers face the grim prospect of earning zero interest on their money. Fixed-rate savings deals are a little higher, but rates have taken a hit with providers pulling products with each base rate cut.
“With the vast majority of accounts this level of return is very difficult to find for higher-rate taxpayers and savers really have to be on their toes to access the best rates,” says Black.
Andrew Hagger, spokesman for comparison website Moneynet.co.uk, says that even best buy savings deals offer taxpayers little return.
A basic-rate taxpayer earning 1.29% on a £1,000 savings pot would see his or her gross return of £12.90 reduce to £10.32 once 20% tax had been applied and then reduced by £31 once inflation was taken into account. This means his or her savings are actually down by £20.68.
A higher-rate taxpayer in the same account would see inflation and tax erode his return by £23.26 after a year.
Even savers in more competitive accounts are unlikely to enjoy the same returns from a year ago.
A basic-rate taxpayer with £1,000 in ICICI Bank’s HiSave 12-month fixed bond paying 4.65% would only earn £6.20 after tax and inflation, while a higher-rate taxpayer would earn £3.10.
Boost your returns:
While it is impossible to beat inflation altogether, there are some things you can do to protect your savings and boost your returns.
* Opt out of paying tax by moving your savings into a cash ISA. You can save up to £3,600 in a cash ISA each tax year and any interest earned will not be taxed.
* If you’ve used your ISA allowance, then move your savings into a more competitive savings account, preferably with a fixed-rate of interest to protect you from further base rate cuts. However, if you need instant access or want to make further deposits then a no-notice or regular savings account must be more suitable.
* Take advantage of accounts offering introductory bonuses but make sure you know when the bonus ends so that, terms permitting, you can then move to another account.
* There are still a number of regular monthly savings accounts paying high rates but these generally limit monthly deposits to no more than £250 and many are conditional in that they require you to have another account with the provider.
* If you’re a higher-rate taxpayer with a mortgage and a reasonable level of savings have a look at offset mortgages.
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.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
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).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
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.