Five ways savers can beat inflation
There's no easy way to beat inflation. The consumer prices index (CPI) is currently 5% while the retail prices index (RPI), which includes housing costs, stands at 5.4%. Both figures are considerably over the Bank of England's 2% inflation target rate and way above the average annual pay increase - wages have only gone up by 2.8% in the past year.
This means our savings are being wiped away. To illustrate: £10,000 saved five years ago, allowing for an average interest rate of 0.94% and 20% tax, would be worth £9,239 today thanks to the eroding effects of inflation. So what can savers do to combat inflation?
1 INDEX-LINKED PRODUCTS
A basic-rate taxpayer would need to find a savings account that pays 6.25% interest to beat inflation, while a higher-rate taxpayer would need 8.33%. The fact that easy-access accounts hover around the 2.5-2.8% mark makes the inflation-beating thresholds look unattainable.
However, there are a few inflation-linked accounts to consider. BM Savings has five-year and three-year inflation linked bonds on offer. The three-year bond pays 0.25% gross interest on top of RPI and the five-year term awards savers with RPI plus 0.5%. The Post Office has two similar inflation-linked bonds, both of which are linked to RPI. Its three-year bond pays 0.25% interest on top of RPI, while its five-year account pays 1% gross interest plus RPI. But those deals are taxable.
2 DEALS FOR EXISTING CUSTOMERS
Both First Direct and HSBC pay existing customers 8% interest for a year's worth of monthly deposits, while Santander pays 5% for 13 months. However, bear in mind you can't deposit a lump sum, and monthly payments are capped – at £300 in the case of First Direct and £250 with HSBC and Santander. This limits the total amount of interest you'll receive.
3 TAX-EFFICIENT SAVING
A basic-rate taxpayer would have to deduct 20% of the interest paid on their savings, and a higher-rate taxpayer 40%. But saving your money in an ISA will ensure that you pocket all the interest you earn. BM Savings also offers three and five-year inflation-linked ISAs.
4 OFFSET MORTGAGES
A potentially better use of your savings if you own a home could be an offset mortgage. These offset any savings and current account balances you hold with the mortgage-lending bank against the total mortgage amount you have to pay back, so you pay interest only on the balance of the debt.
Reducing the amount of interest means more of your monthly payment can be channelled into capital repayment, so you may be able to clear your mortgage more quickly as well as paying less interest in total.
For example, if you had £10,000 worth of savings offset against a 25-year £100,000 mortgage you would reduce the mortgage term by two years and four months and save £15,042 in interest.
5 CONSIDER INVESTING
If you are saving for the long term then equities tend to outperform cash savings. Of course, this involves taking more risk, but spread your money across mainstream sectors such as the UK all companies, UK equity income and global sectors. That way you can keep up with inflation, without taking too much of a risk.
A way of combining a mortgage and savings so the savings “offset” and reduce the mortgage. Rather than earning interest on savings, the savings reduce the mortgage and the interest paid on the borrowing, so savings are effectively earning interest at a higher rate than most mainstream savings accounts will pay. They are also tax-efficient, as savers avoid paying tax on interest that their deposits would otherwise have earned. Offset mortgages offer the disciplined borrower a great deal of flexibility, as overpayments can be made to reduce the term or monthly mortgage repayments, which can save thousands of pounds in interest payments over the mortgage term.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
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.
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.
Regular savings accounts
The attraction of these accounts is the high interest rate they pay. They require customers to deposit money each month, without fail. They come with a number of restrictions, such as monthly deposit limits, no one-off lump sum deposits and restricted withdrawal facilities. Although they are marketed with impressive-looking rates, it’s important to remember that as your money builds up gradually, your overall return will be lower than if you’d deposited a lump sum.
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.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
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).