Worryingly the recent VAT rise from 17.5% to 20% will almost certainly fuel further inflation, which has now remained above the 2% target by one percentage point or more for 13 months.
How savers can beat inflation
In today's low interest rate world inflation is the enemy of savers and people on fixed income. With inflation outstripping most saving account rates, savers are seeing the purchasing power of their nest egg steadily erode away. Unfortunately it is not always possible to completely reverse this erosion but the damage can be limited. Below are some ideas on how savers can beat inflation.
Shop around – comparison sites such as moneyfacts.co.uk will help you find the best savings rate out there. But be careful. Chasing the best rates can have its drawback, read my article Money Tip #100 – The dangers of chasing the best savings rates.
Lock up your savings – as a general rule the longer you lock your savings away the better the rate of interest you earn. The downside is that you will have limited access to your funds and/or will forfeit interest if you withdraw the funds before the agreed fixed term has expired. Coventry Building Society currently offer a bond fixed at 4.75% for 5 years. Don't forget that this interest will be taxed. But non tax payers and basic rate tax payers still win and beat inflation. With the later group getting a inflation busting net rate of 3.8%.
Open a cash ISA – cash ISAs are tax free savings vehicles. That means that any interest is paid gross and is not subject to tax. The result is that you need to achieve a much lower interest rate in order to match inflation, as shown in the table below:
| Cash ISA savings rate needed to match inflation | Interest rate needed from a standard savings account to match inflation | |
| 20% income tax payer | 3.70% | 4.63% |
| 40% income tax payer | 3.70% | 6.17% |
| 50% income tax payer | 3.70% | 7.40% |
The best instant access savings rate on the market at the moment is 2.9% from the Post Office but after tax a basic rate tax payer would receive just 2.32%. By comparison the best cash ISA rate out there is 2.85% tax free from Santander. However you can only save £5,100 into a cash ISA each tax year.
National Savings & Investments Index-Linked Savings Certificates – regular readers will recall me banging on about these last year before the government pulled the plug. Index-Linked Savings Certificates give risk free inflation beating returns for savers but are now only open to existing holders. So if you have some certificates which are due to mature you will probably want to consider rolling them over into a new issue.
Don't pay tax on your savings– apart from cash ISAs it is possible for you to mitigate the tax paid on savings interest. Non-tax payers should always complete an R85 form provided by their bank which will make sure they receive interest gross. But even high rate tax-payers can mitigate income tax on any interest in order to boost their returns. Full details are given in my first ever Money to the Masses post - Money tip #1 – Get bank account interest tax free even if you are a high rate tax payer!
But Mortgage borrowers beware!
Inflation is the borrowers friend as the real value of their debt diminishes over time. The government knows this which is why some people claim that they are purposely trying to inflate away the government debt in order to balance the Treasury's books. However, increasing inflation puts pressure on the Bank of England to increase interest rates (which they hope will in turn reduce inflation). Higher interest rates would mean higher monthly mortgage repayments for borrowers not on fixed rate deals. So you have been warned.
I explain this in more detail, as well as answer the question 'when will interest rates rise?, in my post Latest interest rate predictions – January 2011.
Image: Filomena Scalise / FreeDigitalPhotos.net
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