It’s a miserable time for savers. If you’re a basic-rate taxpayer, you need to find a savings account paying 3.37% or more if you want to stop your savings losing value through tax and inflation. So what can you do?
Savings rates are so low at the moment that many people are actually losing money on their savings.
If your savings account isn’t paying you at least 3.37% interest, your savings will be losing value. Unfortunately, accounts paying that rate or more are thin on the ground.
How your savings are taxed
It’s important to remember that your savings are subject to tax. Any interest you earn on your savings counts as part of your income – so the taxman takes 20% of the interest you earn on your savings before it even reaches your account. (If you’re a higher-rate taxpayer, the taxman takes between 40-50% of the interest).
However one way you can avoid being taxed on your savings is by putting your money into an ISA (which we discuss below).
How inflation hurts your savings
To give you some idea of how damaging inflation can be to savings, here’s a stark fact: if you invested £10,000 five years ago and been taxed at 20% but been paid average interest, your £10,000 would have the spending power of just £8,899 today. Yikes.
It is still possible to beat inflation – the problem is, pretty much all the inflation-beating accounts require you to lock away your cash for years at a time in a fixed-rate account.
But before you rush off to look at fixed-rate accounts, you should be aware that locking away your cash into these accounts comes with two main risks:
- Interest rates can change suddenly. While you may be getting an inflation-beating rate now, who knows what the rates will be in six months time? If rates suddenly go up, you won’t be able to take advantage as your cash will be locked up.
- You won’t be able to access your money. In return for fixing your rate of interest, you can’t touch your money for the term of your account (which can be anything from one to five years). So if you suddenly need a pot of cash to pay for a car breakdown, a new boiler, or some other emergency, bear in mind you won’t be able to use the money you’ve put away in a fixed savings account.
So where can I save and beat inflation?
Not in a current account, that’s for sure – interest rates are dreadful at the moment. At the time of writing the top easy access rate is just 2.4% (and that’s before tax).
There are fixed-rate savings accounts on the market currently paying between 3.2%-3.3% interest, but as mentioned, you will have to lock away your cash for between three to five years to get that rate. That leaves you at risk of being left with a dud deal if rates rise during that time – and you won’t be able to access your money should you suddenly need it.
A good compromise option is to go for a decent Cash ISA. Right now you there are easy-access Cash ISAs paying 3% interest.
Ok, so it’s not a ground-breaking rate of interest, but it’s not bad in the current climate – and remember, because it’s an ISA, you won’t pay tax on any savings you put into it. And with easy-access ISAs, you also get the peace of mind of knowing you can always access your cash should you need it – it isn’t locked away for years at a time.
Get more info on how ISAs work here.