Inflation linked savings accounts: should you believe the hype?


For the past 12 months or so savers have been caught in a perfect storm; inflation has been rising steeply and interest rates continue to run at all time lows.

So where have savers turned to for a real above inflation return?

The answer until the middle of last year was often NS&I (National Savings & Investments) Index Linked Bonds. These provided a return of 1% above RPI, came with three and five year terms, could be surrendered easily and to top it all the interest was tax free. Even the relatively low £15,000 subscription limit could not diminish the value to most investor’s portfolio.

However in early summer last year they were withdrawn and savers looking for a real return from their savings were left desperately searching the best buy tables. For tax payers, even those paying basic rate, this search was often fruitless and where an inflation beating rate could be found it often meant tying savings up for four or even five years.

New launches

Recently we have seen a wave of new savings accounts launched with interest linked to inflation.

The new accounts offered by the likes of the Post Office, Birmingham Midshires and Kent Reliance Building Society, amongst others, all share some common themes with the daddy of all inflation linked savings accounts, the NS&I Index Linked Bond.

To start with they all link the interest you receive to RPI (Retail Price Index) and all provide an additional fixed rate of interest payable on top.

However there are some significant differences. To start with all the recent RPI linked accounts have terms of five years and do not allow access to the capital during that time, NS&I Index Linked Certificates had terms of three and five years.

Furthermore the interest payable on is subject to income tax, the only exception being the Kent Reliance’s Inflation Linked Cash ISA.

Are these accounts the answer to finding a ‘real return’?

Well. yes and no, it all depends on your tax status.

Yes because if you do not pay tax or you open an account as a Cash ISA then the return you get will be at least equal to RPI, indeed if the account also makes a fixed additional payment the return will be above RPI.

No if you are a tax payer and do not use a Cash ISA. The fixed rate of interest payable above RPI is generally insufficient to compensate for the tax you pay, meaning that the actual rate of interest you get after tax will, in most cases, be below inflation.

Should beating RPI be the sole aim for my savings?

Beating RPI will mean your savings retain their buying power relative to inflation.

But just suppose for a moment that the Bank of England is correct in its prediction and inflation falls back towards the end of 2011 and into 2012. If this was to happen and interest rates rise at the same time, you might have been better off taking out a traditional fixed rate savings account.

In times of rising inflation getting a real return on your savings is crucial, however all the inflation linked accounts currently available require your money to be tied up for five years. This is a long time and getting a guaranteed inflation beating return may mean other opportunities could be lost.

So what’s the answer?

It’s a case of stick or twist.

If you are a non taxpayer or plan to save into a Cash ISA you could twist, take the plunge and go for one of the many inflation linked accounts currently available. You know you will beat inflation but you are gambling that at the end of five years the return you get will be better than the alternative accounts you could have had.

If you are a taxpayer, at whatever rate none of the inflation beating accounts currently gives a net, after tax return, that actually does beat RPI. You may therefore decide to hold fire for a while, consider your options and stick, until NS&I announce their plans.