It’s now more expensive to have a cup of tea, an ice-cream, a beer, get a train, go on holiday, buy shoes, eat pizza and play sport. As inflation spirals above 10%, life costs a lot more than it did a year ago, so it is time to make whatever money you have in the bank work as hard as possible.
While the cost of living has gone up, so have the interest rates on bank and building society accounts, so savers can finally see a better return on their cash after a decade in the doldrums. “The key is to make the most of your money now,” says Sarah Coles, personal finance analyst at investment firm Hargreaves Lansdown.
But can I match inflation?
Last week, the Bank of England announced that inflation had hit double digits again at 10.1% – far above its target of 2%. It expects the rate to peak at 11% and then drop to 10% for a few months, before it starts to come down.
Meanwhile, many savers are finally seeing some benefit as many – but not all – banks increase rates. The problem, as investment platform AJ Bell puts it, is that “no savings rate can beat inflation”.
But what the new higher rates can do is come close, says Coles, and may be very close if inflation drops significantly next year.
“Inflation looks backwards, at how prices have changed over the past year, while savings rates look forwards and are fixed for the future,” she says.
“Fixed-rate accounts let you lock in a rate for a specific time, which can be anything between three months and five years. It means that if inflation drops back and interest rates fall during that time, your rate will be guaranteed.”
In the short term…
Conventional savings wisdom says you should have enough money in an easy-access account to cover you for between three and six months of spending, should there be an emergency or you are short of cash.
At the time of writing, financial data site Moneyfacts listed HSBC’s Online Bonus Saver as the best easy-access account with a 3% rate. Gatehouse Bank is offering a 2.8% annual return and Sainsbury’s Bank 2.75% on its Defined Access Saver for deposits of between £1,000 and £500,000. But you are limited to three withdrawals a year with Sainbury’s. NatWest is offering 5.12% on the first £1,000 of its Digital Regular Saver, but that drops to 1% for balances of between £1,001 and £5,000, and 0.5% after that.
… and in the medium
For money you know you will not need for some time, there are good rates, but your cash will be out of reach for at least a year.
For example, DF Capital has a one-year bond at 4.6%. Gatehouse Bank offers the same on an 18-month bond called Woodland Saver, as a tree is planted for every account opened. Both require a £1,000 deposit to start.
Put the money away for two years and the rates are slightly better. Gatehouse Bank is offering 4.8% on a two-year bond. Tesco Bank’s Fixed Rate Saver was last week at 4.77% with a minimum investment of £2,000, while SmartSave was offering 4.76% with a minimum of £10,000.
These accounts could be used for expenses that you know you will be incurring in a year or two, such as planning to pay for a holiday or to do building work.
“It’s more a process of matching your needs to the right account. If you need all of the cash for planned expenses in a year, then all of that bit of your pot might be in a one-year fixed-rate account,” says Coles.
In the longer term
There is little difference in rates for longer terms of up to five years compared to shorter fixes. Moneyfacts puts the best four-year and over fixed rates at 5.1% for a five-year commitment with Gatehouse Bank, and 5.05% for a four-year bond. Close Brothers Savings has a five-year bond at 5.05%
If you are wary about fixing for too long, and do not want to risk a penalty for withdrawing early, you could stagger your investments, says Damien Fahy of Money To The Masses.
“One solution is to use a cash savings ladder, where you split your money across one, two, three, four and five-year fixed-rate bonds. That way, each year one of the bonds matures, giving you access to some of your money, which you can choose to reinvest in a new five-year savings bond, or put in an easy access savings account,” he says.
“Of course, one risk is that savings rates begin to fall in the future.”
Are cash Isas now worth it?
When the personal savings allowance was introduced, many people moved away from cash Isas (where no tax is paid on the interest). The allowance sets a limit for how much you can earn on your savings without paying tax – £1,000 for basic-rate taxpayers, £500 for higher-rate ones, and nothing for additional rate taxpayers.
Since, historically, the rates on cash Isas have been lower than on savings accounts, many people steered away from them. However, with rates increasing, they are now becoming relevant again.
“Most basic-rate taxpayers only receive the £1,000 a year savings allowance. That means they only have to have £20,000 in a savings product earning over 5% to start becoming liable to tax on some of the interest earned,” says Fahy.
“For higher-rate taxpayers, the situation is worse, as you only get a £500 annual savings allowance, while additional rate taxpayers receive no allowance. In recent years, when many savings accounts paid less than 1% interest, you were unlikely to breach your personal allowance unless you had a lot of money. ”
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With the difference in rates between cash Isas and standard savings accounts, for some savers it still makes sense to pay tax and get the higher rate, says Coles.
“If a higher-rate taxpayer has £12,000 on deposit earning anything up to 4.35%, they get into the realms of paying tax,” she says. “The fact that savings accounts tend to pay more interest than their cash Isa equivalents complicates things.
“So a higher-rate taxpayer would actually be better off in an equivalent savings account – which pays 5% – and paying the tax. This means cash Isas tend to be more of an option for additional-rate taxpayers (who don’t have a personal savings allowance) and those with sizeable deposits.”
Last week, Moneyfacts identified one of the best-value cash Isa rates as the 4.35% offered on a three-year fixed-rate account from Virgin Money.