Falling inflation means rising elation for UK savers – and here’s why

Wednesday, February 19, 2014

Inflation has fallen, which is welcome news for the UK's savers. While you may agree with that statement, do you really understand why it's a good thing - and how your savings could benefit as a result?

Cost of living blogJanuary may have been the wettest month on record for many, but it also brought some welcome news for the nation's households. Inflation - the rate at which our cost of living changes - fell to 2% in December.

As the rate of inflation is based on the cost of a basket of consumer goods and services, seeing it fall is great news. At 2% it means that, if your weekly shopping is £100, you'd need £102 to buy the same items in 12 months' time. After five years, you'd need just over £110 and after 10 years, £122.

 

What's the wider picture?

But it's not just about the household budget - a fall in the rate of inflation can also benefit savers. If you want your savings to maintain their spending power and not lose value over time, you need to find an account that pays interest at a higher rate than inflation.

With inflation at 2%, this means a basic rate taxpayer needs an account with a gross interest rate of at least 2.5%, while a higher rate taxpayer needs a rate above 3.34% to take into account the higher rate of tax they'll pay on the interest.

Although the fall in the cost of living has boosted the number of inflation-beating savings accounts, you might want to put some other strategies in place to ensure your money isn't wasting away.

Take a tax-free option

Using an ISA or a tax-exempt savings scheme means you won't need to pay any tax on the interest you receive. So, as long as the interest rate is higher than the rate of inflation, the spending power of your money will grow.

Take advantage of a partner's tax band

Couples can cut the tax bill on their savings by putting their money into the name of the person with the lower tax rate. For example Mr Smith is a basic rate taxpayer and his wife, Mrs Smith, is a higher rate taxpayer. They each have savings of £2,500 earning 2% interest. After tax Mr Smith receives £40 in interest each year while his wife receives £30. By putting all the money in Mr Smith's name, they'd earn an additional £10 a year.

Go longer term

If you're happy to leave your money tied up for longer, chances are you'll be rewarded with a higher interest rate. For example, according to Moneyfacts1, while you would only get a top rate of 1.60% on an easy access account, this increases to 1.80% if you're comfortable giving 120 days' notice. Leave it for five years in a fixed rate bond and the rate powers up to 3.25%.

Increase the risk

Although there's a risk that your money will fall in value if you invest it in the stock market, studies2 show that if you're able to leave your money, it will usually deliver a higher return than if you'd opted for a savings account. For example, looking at every five-year period since 1899, the UK stock market would have beaten cash 74% of the time. Increase your investment timeframe to 18 years, and the probability of a better return increases to 99%. 

That said, everybody is different when it comes to attitude to risk, and if you prefer a more cautious approach, with profits may offer a solution. These mid to long-term plans offer the potential for greater growth than deposit accounts but with less risk than stocks and shares-based investments.

Going up

The key is to make your money work harder, in whichever way feels more comfortable for you. Inflation has fallen, and your savings need to grow.


Sources:

  1. Money Facts, Best Savings Rates - Rates taken for 02/02/14 - Easy Access Savings Accounts (no bonus) - Kent Reliance Easy Access Savings Issue 6 - 1.60%; Notice Accounts - Shawbrook 120 day notice personal savings account issue 12 - 1.80%: Fixed Rate Bonds (4 years & over) - UBL five year fixed term deposit - 3.25%)
  2. Barclays Equity Gilt Study 58th edition 2013
 
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