Savings rates to beat inflation
News that the rate of inflation jumped last month has come as a double blow to savers, who are already having to contend with low returns on their cash.
The latest figures show there was a shock jump in the official rate of inflation in December, from 1.9% the previous month to 2.9%. This is the largest jump in the annual rate since records began in 1997.
Inflation now stands at a nine-month high, pushed up by the unfavourable base effects resulting from the temporary VAT rate of 15% and oil prices falling sharply in December 2008. Lower levels of discounting by retailers last month compared with a year ago also contributed to the rise.
Inflation is bad news for savers as it effectively erodes the real value of your money.
Taking the current rate of inflation into account, a basic-rate taxpayer now needs to find a savings account that pays at least 3.63% in interest to stop their savings pot eroding away, according to date provider Moneyfacts.
Higher-rate taxpayers, meanwhile, needs to find an account that pays at least 4.81%.
However, savings rates look to have hit rock bottom, with the average instant access account paying around 0.75%. Shockingly, after tax and inflation, the average return on an instant access account is minus 2.3%.
Darren Cook, spokesman for Moneyfacts, says: “This is extremely unfair for those savers who have made prudent or astute decisions in the past and are being hit by low savings rates and spiralling inflation.”
Sadly, even market-leading instant access accounts provide little protection from inflation - according to Moneyfacts, there are currently no variable-rate accounts paying interest above 3.63%.
The first home for your cash savings should always be a cash ISA - anyone over the age of 16 can save £3,600 this tax year in a cash ISA, rising to £5,100 for people aged 50 or over.
The benefit of cash ISAs is that your money will grow free of tax.
However, average rates on tax-efficient cash ISAs offer little protection from the erosive impact of rising inflation. The average interest rate on a variable ISA is currently just 1.31%. On a £3,600 balance, this means savers will only earn £8.72 in interest, rising to £12.34 for savers over the age of 50.
While fixed-rate ISAs offer slightly better rates, the average return on a one-year account is still just 2.7% – equal to £14.76 annual interest on a £3,600 balance. Older savers able to put up to £5,100 in a cash ISA this tax year will still only earn £20.91 a year on average.
“The current low-interest rate landscape is really hurting savers with inflation wiping out the spending power of their cash, and even when you opt for the tax free option that the government encourages us to take advantage of, the returns are still quite pitiful,” says Andrew Hagger, spokesman for comparison website Moneynet.
Inflation-busting savings accounts
If you've already used your ISA allowance, then a fixed-rate account is the next best place for your money at the moment, as rates are more generous than instant access deals.
However, bear in mind that you won't be able to access your money during the term of the account - this can range from 12 months to five years. You're also unlikely to be allowed to put additional money into your account beyond the initial deposit.
|Birmingham Midshires||5.1%||Five years||£1|
|The AA Savings||5.1%||Five years||£500|
|Birmingham Midshires||5%||Four years||£1|
|ICICI Bank||4.25%||Two years||£1,000|
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).
Where APR is the rate charged for money borrowed, Annual equivalent rate is how interest is calculated on money saved. The AER takes into account the frequency the product pays interest and how that interest compounds. So, if two savings products pay the same rate of interest but one pays interest more frequently, that account compounds the interest more frequently and will have a higher AER.
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.