Interest rates may be low but a drop in inflation makes money go further

Published on Saturday 18 July 2009 14:18

DESPITE low interest rates, savers can now enjoy the best returns in five years, after inflation is taken into account, according to savings researchers at Moneyfacts.

In general, the cost of living, as measured by the Retail Prices Index fell in June by 1.6 per cent compared with a year ago. Even the government's preferred inflation index, the Consumer Prices Index, from which housing costs are stripped out, slipped below its target 2 per cent to 1.8 per cent.

While falling prices are bad news for anyone with debts, they can bring some comfort to savers, forced to endure low interest. The fall means 100 in a savings account is already boosted by a 1.6 per cent return before any interest is added, if measured against RPI.

It's not such a welcome picture when pitched against CPI, where prices are still rising, just not as quickly, and your savings must earn a post-tax return of 1.8 per cent to retain their buying power. But at these levels there is now a real prospect that savings can keep pace with inflation.

However, savers must be vigilant, as institutions are skilled at luring them in with eye-catching returns which are later slashed.

Scotland on Sunday has come up with 20 tips to make the most of your savings.

1. Become a money detective

It is vital to keep an eye on your savings and always know precisely what interest you are being paid. Check this regularly against the best-buy tables to make sure your account is not falling behind.

2. Be a rate tart

Move aggressively to the best-paying accounts.

3. Give the branch a miss

Branch accounts are convenient, but you pay for that extra service. You will usually earn more if you manage your savings by post, on the telephone or over the internet.

4. Tie your money up

Although banks have been sneakily increasing the interest they charge borrowers, they have not been passing this money on to savers, with one exception.

Interest has been creeping up on accounts which tie your money in. The Post Office, for example, last week launched a new range of fixed rate accounts, Growth Bond Issue 9, paying 3.85 per cent over one year, 4.15 per cent if you fix for three years and 4.5 per cent if you fix for five, on a minimum 500 deposit.

Elsewhere, the Yorkshire Building Society has a three-year bond paying 5 per cent, and the Dunfermline 3.75 per cent on a one-year bond.

Be cautious about tying your cash up for too long, as interest rates will rise again. Three years is probably long enough.

5. Don't pay tax

It is vital to protect your savings from tax by investing in a tax-free individual savings account (Isa). Taxpayers lose 20 per cent of any savings return in tax, or 40 per cent if you are a higher rate taxpayer.

The Manchester Building Society is currently offering the best rate to new Isa savers at 3.26 per cent with a 45-day notice period, with the Newcastle paying 3 per cent with a 120-day notice period. Both accounts can be operated by post.

6. Transfer your Isa nest egg

The best rate when you began saving five or ten years ago may not be the best rate now. Do not be afraid to transfer all your Isa savings in one go. Leeds Building Society is currently accepting transfers on a 4.05 per cent rate.

7. Save regularly

Some of the best current returns are available on regular savings accounts. The Scottish Building Society is paying 4 per cent on monthly savings of between 2 and 500. Barclays will pay 4.17 per cent on a minimum 20 to 250.

Saving small amounts regularly is the best way of building a nest egg without having to make any big sacrifices.

8. Don't forget the children

Saving can be hardest when bringing up a family, so it is crucial to exploit every opportunity which comes your way. Children have their own personal income tax allowance which allows them to earn 6,475 annually without paying any tax. This is a good way for relatives to pass money on to the next generation. They can also earn 100 income from cash given to them by each of their parents.

Once parents have fully exhausted their Isa allowances, then extra cash should be put into the children's accounts.

9. Building for the future

Tax breaks available with child trust funds should not be ignored when saving long-term to meet your offspring's university costs. But remember: this money is locked away until they are 18.

10. Pay off your credit card

There is no point in saving, while you have outstanding debts. Paying off your credit card could give you a return of between 10 and 25 per cent, depending on the rate.

11. Reduce your mortgage

Using excess cash to reduce your mortgage will not only give you a return, depending on the rate, of anything between 2 per cent and 7 per cent, but you can add another 20 per cent to this to reflect the tax you may have paid on your savings.

This could give a higher rate taxpayer a return of nearly 10 per cent.

But the savings are even greater, as paying off the mortgage early reduces not only the interest you pay, but the time over which you are paying it. So it has a cumulative effect.

Be careful, though, about reducing your mortgage if you have any threat of redundancy, as you may need this money. Also think carefully if you have a very low rate of interest on a tracker loan. You may get a better return by putting money in a savings account elsewhere instead.

12. Offset loans

You can reduce your mortgage repayments by "offsetting" savings against your mortgage balance. This can be particularly valuable to the self-employed, who may keep large amounts on deposit waiting to pay tax bills.

13. First-time buyer accounts

Britannia has a special account for first-time buyers, paying 2.5 per cent on more than 250. Not a brilliant rate, but it may be worth considering once your Isas are full and if you don't want to tie your money up.

14. Lend a hand loans

Alternatively, parents who offer to guarantee their offspring's loan with Lloyds can earn 4 per cent fixed for 42 months on the cash they put down as backing.

15. Silver savers

A number of building societies, such as the Leeds and Coventry, have instant access accounts available to the over-50s or over-60s paying around 2.25 per cent.

16. Annuities

If you need income you could consider paying some of your money into an annuity, which is currently offering a 65-year-old a 7 per cent annual return, including the return of your capital.

17. Immediate vesting pension plans

You can exploit tax relief to boost your long-term financial planning. It is possible to invest in an immediate vesting pension plan, which gives you tax relief of up to 40 per cent but then allows you to withdraw a quarter immediately as tax-free cash. The rest is used to buy a pension at a later date.

18. Keep an eye on inflation

Though deflation is the bigger worry, some think inflation could be a threat to our savings in the months ahead. For a bit of inflation-proofing, consider National Savings index-linked certificates, which have the added bonus of being tax-free, so are particularly attractive to higher rate taxpayers. These are currently paying 1 per cent above RPI, not exactly a steal with RPI in negative territory, but one to watch if inflationary pressures build.

19. Rising income stream

Consider shares or funds with a steady and rising income stream.

20. Spend, spend, spend

There are all kinds of bargains around right now, from consumer goods to cars and property. The best medium-term investment you could make might be to cash in on the bargains by refurbishing your house, updating the car or investing in a buy-to-let property.