Savers are still putting millions of pounds into inflation linked savings accounts, but with last month’s fall in the rate of inflation and predictions from the Bank of England that it will fall further, possibly below their 2% target, is now the time to link your savings to inflation?
The inflation problem
We all know what a toxic combination high inflation and low interest rates can be.
Last month the Consumer Prices Index (CPI) stood at 5%, down 0.2% on the previous month, RPI (Retail Prices index) fell by the same amount to 5.4%.
Searching the best savings interest rates shows the simple truth, that there are no savings accounts which pay a rate of interest, net of tax, equal to either measure of inflation, meaning that the buying power of your savings will be eroded.
If you are a non tax payer there are only a handful of accounts which pay an interest rate above inflation, and even then you will need to tie up your savings in a five year fixed rate bond.
How do inflation linked savings accounts work?
Most inflation linked savings accounts are based on National Savings (NS&I) Index Linked Certificates, which were withdrawn earlier this year.
Since the withdrawal of the NS&I products banks and building societies have launched a variety of index linked savings accounts with returns linked to RPI often plus a small fixed rate of interest; these accounts generally have terms of three or five years.
One of the major differences though between these accounts and the NS&I Index Linked Certificates though is access. With the NS&I Certificates you could withdraw your money at any time without penalty, albeit no interest was credited if you withdrew in the first year. However, the majority of the inflation linked accounts offered by banks and building societies have limited withdrawal capability. Some do not allow withdrawals, some allowing them in exceptional circumstances and those who do allow early access charge a significant penalty.
The other difference is of course tax. Any return from the NS&I Index linked Certificates is tax free, this is not the case with the accounts offered by banks and building societies, unless the account is linked to a Cash ISA, which limits the amount which can be invested to £5,340 in the current tax year.
Pros and cons
In general, the inflation linked savings accounts offered by banks and building societies are the poorer cousins of NS&I Index Linked Certificates, offering lower returns, limited access to savings, and are not generally as tax efficient.
However, despite the fact they are not as attractive as the NS&I Certificates, the new breed of inflation linked accounts are by all accounts flying off the shelves.
Given the relatively high rate of inflation we are currently experiencing, are savers right to be investing in these inflation linked accounts?
As with any investment there are advantages and disadvantages.
- For a non taxpayer, or if you are saving via a Cash ISA the return should be equal to or better than inflation over the term of the account
- If inflation rises then so will your return
- For tax payers the return is guaranteed to be below inflation due to the tax payable on the interest received
- Access to the inflation linked accounts offered by the banks and building societies is generally limited with heavy penalties payable on withdrawals. Some accounts offer no early access whatsoever
- If inflation falls over the term so will your return meaning that other savings accounts may pay a better rate of return, especially if interest rates rise. If no early access is allowed or penalties charged then it may not be possible to move to a more attractive savings account
Is now the right time to be linking your savings to inflation?
It partly depends on your view of inflation and the interest rate available on other savings accounts, however for us the key issue is also access to your savings.
Many people, including Mervyn King, the Governor of the Bank of England, believe inflation will fall back in 2012 and 2013. Others however point out that the economy has been boosted by additional Quantitative Easing measures which could push inflation up still further in years to come. Tony Nutt of Jupiter has predicted that inflation could rise to 8% by 2015 .
The first problem is that for tax payers these accounts do not actually accomplish their goal of beating inflation, tax paid on the interest means that the return will generally be below inflation.
The second problem concerns access. When you opt for an inflation linked account and cannot access your savings during the term, if inflation falls you may find that you would have been better off in a more traditional savings account.
NS&I Index Linked Certificates gave you the best of both worlds, access to tax free inflation linked returns when you wanted them with access to your savings if inflation fell and you could get a better rate of interest elsewhere.
The current crop of inflation linked savings accounts do not allow such easy access, if you use them you are therefore taking a gamble on the direction of interest rates and inflation over the next few years.
No one has a crystal ball, predicting the direction of interest rates and inflation has rarely been harder, but our own view is that due to the inflexible nature of these accounts and the predications for inflation to fall in 2012 and 2013 we currently prefer to avoid these inflation linked accounts.
Our view might change if a bank or building society could offer such an account with easier access, but this is unlikely given the way that the products are put together.
It just shows what good value NS&I Index Linked Certificates offered, they are missed, and their return in 2012 will be eagerly anticipated by savers.
If you are looking for best savings interest rates use our online tables to help find the most competitive accounts.
If you are concerned about the effects that inflation is having on your savings or would like to review where your savings and investments are currently held our team of highly qualified and experienced Independent Financial Advisers are here to help you.
They can be contacted on 0115 933 84 33 or by emailing firstname.lastname@example.org