Savers – beware the return of inflation
News that the rate of inflation jumped last month has come as a double blow to savers with many of the top deals being pulled in recent weeks.
Earlier this week, official figures revealed that one measure of inflation – the Retail Prices Index - increased for the first time since April 1990 by more than 1.1%. Although it remains low at just 0.3%, the Consumer Prices Index (CPI) – the official measure of inflation – also rose during November to 1.9% and experts predict it could hit the 3%-mark early next year.
David Page, economist at Investec Securities, says: “The next few months are likely to see CPI inflation jump sharply as the anniversary of last year’s VAT cut passes and subsequently as the VAT headline rate returns to 17.5%. These effects are likely to push CPI inflation above 3% in January.”
Although many economists expect this sharp rise to be temporary, others warn there is a potential for inflation to remain high.
“As the world comes out of recession, demand for raw materials goes up, as do prices, which in turn has a knock on affect on inflation,” says Mark Bolsom, head of UK trading desk at Travelex. “Stronger oil prices have had an upward impact on inflation figures and we expect this to continue rising.”
Rising inflation could prompt the Bank of England to slowly start to increase the base rate - rises that should, in theory, be passed on to savers. However, for the time being the base rate remains at an all-time low of just 0.5% - and savings providers have recently been pulling their most competitive deals.
The past couple of weeks have seen many big-name banks and building societies closing savings accounts to new customers. For example, the Post Office pulled its popular one-year fixed-rate deal (paying 3.7%), while Skipton ditched its five-year fix paying 5.35%.
Andrew Hagger, spokesman for Moneynet.co.uk, says fixed-rate accounts have a short shelf life at the moment because of high demand from consumers.
“People coming to the end of a very attractive deal from one or two years ago [are now] trying to lock in to the very best rate they can find as a replacement,” he explains.
Just 12 months ago, ICICI Bank and Anglo Irish were offering rates of 5.75% for one year, while in December 2007 one of the top deals was Halifax’s 6.45% two-year fix.
Savers who took advantage back then may well be shocked by the rates currently on the market – according to the Bank of England, the average fixed-rate bond paid just 2.64% in November.
Alongside disappointing returns, savers must also contend with the erosive threat posed by rising inflation.
Darren Cook, spokesman for data provider Moneyfacts, says pensioners are especially affected.
"Low bank base rates are designed to encourage savers to plough their savings back into the economy, but this serves little or no benefit to those who rely on interest from their hard earned wealth to subsidise their pension,” he explains. "Most pensioners are seeing their savings being eroded on average by 1.25% per year for a basic-rate taxpayer and 1.41% for a higher-rate taxpayer.”
With CPI inflation at 1.9%, a higher-rate taxpayer will need to find a rate of 3.17% to maintain the spending power of their savings pot, according to Hagger. "Basic-rate taxpayers will now need to secure at rate of at least 2.37%."
An estimated 80% of all variable-rate accounts pay less than 2.37% - which is why so many savers are opting for fixed-rate deals instead, where interest rates are slightly more generous.
How to beat rising inflation while rates are low
The first thing to do is find out what interest you are currently earning on your savings – if in doubt, call up your provider to find out. If you have an instant access or any other type of account paying a variable rate of interest, then you should aim to regularly review this to make sure your interest hasn’t been cut without you realising.
Once you’ve found out the interest rate your nest egg is attracting, the next step is to see if you could find a more profitable account for it.
The first home for your savings should always be a cash ISA – anyone over the age of 16 can save £3,600 in a cash ISA each tax year, and if you are over the age of 50 can save £5,100. From April 2010, everyone over the age of 16 will benefit from this higher ISA allowance.
The benefit of savings in a cash ISA is that all the interest you earn will be free of tax. Generally speaking, there are three types of cash ISAs – easy access, fixed-rate and regular.
The same is true of ‘non-ISA’ savings accounts. If you want access to your savings, then easy access is probably your best option. You can either opt for instant access or a notice account – as the name suggests, the latter requires you to give notice, and this can range from 60 days to three months.
Easy access accounts are ideal if you want a rainy-day fund where you can make withdrawals or additional deposits as and when. However, be aware that because the interest rate will be variable, your return is not guaranteed.
In addition, many accounts have withdrawal restrictions (for example, no more than three withdrawals a year) so accessing your money might not be easy as you’d like. Check the terms and conditions before you sign up.
If you have a lump sum of money that you’d like to lock away for the future, then a fixed-rate account might be the right home for you. You can choose to fix for anything from nine months to five years, or even longer in some cases. The term that’s right for you will depend on how soon you think you'd like to access the money and your expectations for interest rates ahead.
The advantage of fixed-interest savings accounts is that you know exactly how much interest you’ll earn. However, if you sign up to a three-year account you may find that, one year down the line, rates on new fixed accounts have increased, effectively meaning you’re losing out.
The other disadvantage is that, if you try to touch your money during the fixed-rate term, you’ll lose interest or even see the account shut down. Most fixed-rate accounts do not allow further deposits either.
If you want to cultivate a savings habit, then a regular account might be a good option. These require you to set up a monthly standing order from your current account, so you put away a set amount each month. You can either opt for a fixed or variable rate, and some providers will also allow you to make withdrawals in an emergency.
Just remember, though, if you miss a monthly payment you may be hit with a penalty charge or see your interest rate fall for that month only. You can also get regular ISA savings accounts, so this is another option if you haven’t used your allowance.
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.
A savings account on which the account holder is required to give a period of notice before making a withdrawal or face a penalty, usually a loss of a specific number of days’ interest or pay a fee. Notice periods of 30, 60 or 90 days are common. These accounts usually pay higher than average interest rates and require large initial deposits (£1,000 minimum) so the notice period and penalties are there to discourage withdrawals. Some of these accounts will only allow a certain number of withdrawals a year.
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.
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.
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).
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
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.