Are you struggling with the rising cost of living? Find out which savings accounts and ISAs will help you beat inflation.
This article was first sent to Fools as part of our 'Summer Lolly' email campaign.
What have you been up to this summer? Unless you've been living in a cave and surviving on a diet of berries, then you probably know how steeply the cost of living is rising. Indeed, the cost of energy, food and fuel seem to be going through the roof at present.
Over time, price rises produce higher inflation, which is why, last month, one measure of inflation - known as the Retail Price Index (RPI) - leapt from 3.8% to 4.2%.
Together, inflation and tax harm savers
Inflation is a nightmare for savers, because it erodes the value of their cash deposits. For example, with inflation at 4% a year, the value of money halves every seventeen years. In this case, £1 would buy goods worth just 25p (in today's terms) after 34 years.
Thus, it's essential for savers to ensure that their savings interest rate is high enough to beat inflation. Otherwise, they will see a decline in the `real' (inflation-adjusted) value of their nest egg, emergency fund or rainy-day money.
Even worse, the taxman is lurking in the wings, ready to grab a slice of savings interest earned by taxpayers. Basic-rate taxpayers lose a fifth (20%) of their savings interest to HM Revenue & Customs. In their case, tax reduces a savings rate of, say, 5% to 4% after tax. For higher-rate taxpayers, the problem is doubled, because they lose two-fifths (40%) of their savings interest to HMRC. This slashes a rate of 5% to a mere 3%.
At certain times in recent economic history, inflation has soared so high that no savings account has been able to keep up. For instance, in August 1975, the RPI hit a whopping 26.9% - a rate that no saver could hope to match.
However, over the past ten years, the RPI has varied between 0.7% and 4.8%, which is much less of a challenge for savers.
Can savers beat inflation today?
The answer to this question very much depends on your personal tax rate. The table below shows how much savers would have to earn in order to match the current RPI (4.2%), after accounting for tax:
Tax rate | Rate required to earn 4.2% a year after tax |
|---|---|
Non-taxpayer (0%) | 4.2% |
Basic rate (20%) | 5.2% |
Higher rate (40%) | 7.0% |
As you can see, a basic-rate taxpayer would need to earn 5.25% a year in order to match the RPI rate of inflation. With the Bank of England's base rate currently at 5% a year, it's not difficult to find savings accounts in this category. Indeed, I easily found more than a hundred different accounts which pay 5.25% a year before tax.
However, life is much tougher for higher-rate taxpayers, who have to find a savings rate of at least 7% a year merely to keep up with RPI. Alas, there are no everyday, easy-access savings accounts which pay 7%+ a year. To get a rate this high, savers have to lock up their money for extended periods.
How taxpayers can beat inflation
1. Cash ISAs (Individual Savings Accounts)
If you are a UK resident aged sixteen or over, then you can open a super savings account known as a cash ISA. A cash ISA pays tax-free interest which you do not need to declare on your tax return. As you'd imagine, cash ISAs come with strings attached. For example, you cannot deposit more than £3,600 into a cash ISA in any tax year. For more information, visit our cash ISA centre.
2. Fixed-rate accounts
You can earn more interest by agreeing to fix your interest rate for a period of at least a year. However, fixed-rate bonds often have strict penalties for withdrawals or early closure, so check the terms and conditions before locking away your money. These bonds top the Best Buy tables:
Account | Interest rate (% AER) | Term | Min/max deposit (£) |
|---|---|---|---|
FirstSave Fixed Rate Bond | 7.10% | One, two or three years | 1,000/2m |
7.01% | One year | 1,000/2m | |
ICICI Bank HiSAVE Term Deposit | 7.00% | One year | 1,000/No max |
3. Regular-savings accounts
With a regular-savings account, you agree to make monthly deposits for a fixed period, usually a year. In return for not withdrawing any money, you enjoy a super-sized savings rate. Best Buys for new and existing savers include:
Account | Interest rate (% AER) | Min/max deposit (£) |
|---|---|---|
Halifax Children's Regular Saver | 10.00% | 10/100 |
Abbey Fixed Monthly Saver | 7.25% | 20/250 |
Principality BS Regular Saver Bond 5 | 7.00% | 20/500 |
Halifax Regular Saver | 7.00% | 25/250 |
4. National Savings & Investments (NS&I)
One guaranteed way to beat inflation is to save in the government's piggybank, National Savings & Investments. NS&I offers tax-free Index-Linked Savings Certificates with returns linked to the RPI. Here is the current crop:
Account | Interest rate (% AER) | Term (years) | Min/max deposit (£) |
|---|---|---|---|
Index-Linked Savings Certificate 17th issue | RPI+0.70% | Three | 100/15,000 |
Index-Linked Savings Certificate 44th issue | RPI+0.70% | Five | 100/15,000 |
Finally, one good way to beat inflation over the long term is to invest in businesses via the stock market. One easy way to do this is to invest in an index tracker. Over time, this cheap, simple investment will capture almost all of the returns from the UK stock market. So, if the world economy does well, so too will your investment.
Good luck in your battle against inflation!
Visit The Fool's Savings Centre to find an inflation-busting savings account!