A guide to inflation-linked savings accounts
By Kate Saines
The problem with saving money these days is it’s almost impossible to find a place to stash your cash where you’ll also receive a return that’s worthwhile.
This is because inflation is high and savings rates are low. So any interest you earn on your money will be instantly eaten up by the rising price of what’s in our shopping baskets.
It’s fair to say that people – savers particularly – are worried.
So it will come as no surprise to hear a barrage of products have recently hit the market which promise inflation-beating rates.
But are these accounts the answer to savers’ prayers or too good to be true? Here’s the lowdown.
The principle
Inflation is measured using two indices. There is the Retail Price Index (RPI), which is published by the Office of National Statistics and shows the rate at which the price of a basket of retail goods changes.
The second is the Consumer Price Index (CPI), based on the Harmonised Consumer Index Prices, which measures inflation across Europe, and this also measures the change in price of a basket of goods.
The RPI includes council tax and mortgage interest repayments, the CPI does not. The CPI, however, is based on figures gathered from a wider range of the population.
Currently inflation according to the RPI is at 5.5 per cent, and CPI inflation is at 4.4 per cent.
Both measures are used by different organisations – most significantly the Bank of England uses CPI. But whatever measure you use – inflation is high at the moment.
What the banks have done is create a variety of savings products which promise to provide an interest rate above inflation.
The idea is that if people are receiving a higher rate of interest on their savings than the rate the price of their households goods is rising – the power of their pound is greater.
If you consider the RPI is at 5.5 per cent – you’ll currently be getting a rate of 5.5 per cent on an inflation-linked account.
What most providers do, however, is provide customers with an additional ‘bonus’ on top of inflation. If this is 0.5 per cent, you’ll be looking at earning six per cent at the moment.
The Products
To give you a flavour of the kinds of products which are doing this sterling job of boosting our spending power, the most recent inflation-linked account to be unveiled is the Principality Protected Capital Account.
It’s a five-year investment offering yearly interest based on changes in the RPI, plus an ‘annual enhancement’ of 0.20 per cent.
And you can have all this in return for a minimum deposit of £3,000.
It’s being hailed by Principality as an opportunity for savers to protect the value of their savings from being eroded by inflation.
Paul Straiton, the building society’s product manager, said: “We understand that some savers are concerned that the level of inflation is eroding the value of their savings, particularly as the RPI has recently hit a 20-year high.”
He added: “We believe our Protected Capital Account can help savers outpace inflation and increase the purchasing power of their savings.”
Savers can also invest in the product using their cash ISA allowance which means they’ll also be protecting their interest from tax.
The Post Office has also got on the band wagon. It launched what it describes as the ‘best’ inflation-beating five year bond on the market in February.
It offers returns linked to the level of the RPI as measured at April each year plus another 1.5 per cent annually. It’s that 1.5 per cent which guarantees it will beat inflation.
If, in any year, the RPI was negative the return would be 1.5 per cent.
You’ll need £500 to open the bond, which ties your money up for five years.
February was also the month Yorkshire Building Society released its inflation-linked deposit accounts.
Once again, these products are five-year plans which pay interest linked to the RPI. A maturity return option provides interest at the percentage change in the RPI over the five-year investment period plus 1.5 per cent.
There’s also an annual income version which guarantees savers an annual return of 0.1 per cent plus the annual change in the RPI over each 12 month period.
Simon Broadley, the Yorkshire’s retail investment manager, said the products allowed customers to maintain the true spending power of their savings.
“By choosing this product,” he promises, “[members] can be confident that their savings will track inflation irrespective of what happens over the coming years.”
Find out all the latest product news concerning savings bonds here.
The problem
All this sounds great, and indeed these products have been welcomed with open arms to the market.
Kevin Mountford, head of banking at Moneysupermarket.com, believes consumers will ‘flock’ to the products.
However, there is one very big pitfall of these kinds of savings plans which is that inflation can go up as well as down. And if inflation plunges, so will your savings rate.
Principality clearly states that during the account’s five year term, interest is calculated on an annual basis using the percentage change in the RPI – negative or positive – over that time.
And five years is a very long time – plenty of things can happen during that kind of period.
Kevin Mountford explains: “Although inflation is currently high, the benefits will only be in the short term.
“The likelihood is that inflation will start to fall towards the end of the year, while Base Rate will fall at some point,” he said.
“Anyone considering inflation-linked savings products needs to balance the risk of variable rates against the certainty of fixed-rate products.”
Mr Mountford said there are currently some good rates on fixed-rate ISAs and bonds of up to 4.75 per cent.
Over the five-year period many of these inflation-linked savings plans are running you could be earning a guaranteed rate which might be a little lower than the inflation-beaters today but will be much higher in five years.
“Over a five year term,” said Mr Mountford, “the return may be higher, especially once the Bank of England brings inflation back under control.”
And don’t forget about tax. Although some of these inflation-linked accounts do have ISA options, the ones which don’t will not shelter your interest from the tax man. And therefore what you’ll gain in beating inflation you’ll lose in capital gains and income tax.
The conclusion
As with many high-returning investments, there’s always a gamble involved. Listening to the government’s Budget announcement last month it would seem we are heading for a lot more inflation which would mean these accounts could be a good bet.
But the five-year lock-in is likely to make us think twice.
Do your research and make sure, before you open an inflation-linked account, you know all your alternatives.
Use the Myfinances.co.uk comparison tables to find the best deal on a savings account or savings bond.
Comments
Newsletter sign up