When the only way is down: Maintaining the value of your savings can be a daunting task

Published on Thursday 22 July 2010 15:14

PROTECTING the value of their money is the very least that savers should expect to do. Unfortunately, in the current environment that is virtually impossible, and investors should brace themselves to watch their hard-earned cash eroded by inflation.

The decision by the government's savings arm, National Savings & Investments, to axe tax-free savings certificates will come as a blow to savers. The index-linked certificates, in particular, which paid 1 per cent on top of the retail prices index, was the best safe hedge against inflation available.

To inflation-proof their nest eggs, and beat the Retail Prices Index of 5 per cent, basic rate taxpayers need to earn 6.25 per cent or 8.33 per cent for higher earners. These kinds of rates are simply not available in deposit accounts.

The government's preferred measure of inflation, the Consumer Price Index, tends to be lower than RPI because it excludes housing costs and is currently 3.2 per cent. You need to earn 4 per cent as a basic rate taxpayer and 5.33 per cent if you pay higher rates of tax, to top that, which can be achieved with wise investing.

More worryingly, there may be more inflationary erosion coming down the tracks. Higher VAT and mortgage repayments will push the measures up when they kick in. Little wonder the government's savings arm has lost its appetite for index-linking.

In fact, it seems to have lost its appetite for taking in money at all, no longer offering any unique tax-free products and paying pitiful returns. This follows months of bumper inflows.

The best of NS&I's offerings is now the direct Isa, paying 2.5 per cent on a minimum balance of 100, which can be bought over the telephone or internet. However, many savers will be trapped in NS&I's old Post Office-based cash Isa, which closed a little while ago, and is now paying an abysmal 0.5 per cent interest.

NS&I has written to customers advising them to switch to the superior return available on the direct Isa. Wherever you decide to move your money, it should come out of that old Post Office account pronto.

Premium Bonds continue to be a favourite, with prizes also tax-free. This game of chance has a minimum investment of 100 and maximum 30,000. Instead of interest, your investment is entered into a monthly draw

With the maximum 30,000 invested and average luck you should receive the average 1.5 per cent return. Some people will have better luck and some worse, and the fewer bonds you have the poorer the likely return.

Finally, tax-free children's bonus bonds pay 2.5 per cent on sums of at least 25. But most children enjoy tax-free interest, as they do not fully use their personal allowance of 6,475, so the tax-free status is not much of a gift to most young people.But even when it comes to NS&I's taxable accounts, the return is heart-stopping. Always popular, income bonds, are now paying a less than cockle-warming 1.45 per cent up to 25,000 and 1.75 per cent above that up to 1 million. The Post Office-based Investment Account, with an old fashioned pass book pays between 0.2 to 0.3 per cent. Alternatively, with a cash card the return varies between 0.3 and 0.7 per cent. Don't all rush at once.

Finally, it offers a direct saver account which can be run online or over the telephone and which pays 1.75 per cent.

So where else can savers turn? Firstly, it is crucial to protect whatever return you can achieve from tax. Tax will lop 20 per cent off interest paid to standard rate taxpayers, and 40 or 50 per cent off the income of the better off, so it is vital to maximise the tax-free shelter offered by savings accounts such as Isas (Individual Savings Accounts).

You can invest 5,100 in a cash Isa annually, with a further 10,200 in a stocks and shares version. Alternatively, you can invest all your Isa allowance of 10,200 in stocks and shares. Even here the returns are anaemic.

Nationwide has an E-Isa paying 2.75 per cent, of which 1 per cent is a bonus, with the same rate available at the Newcastle Building Society. These are the best around for variable Isas. You can do better if you want to tie up some of your cash for a few years. Birmingham Midshires will fix the rate at 4.25 per cent for five years, and Nationwide and Dunfermline at 4.15 per cent over four years.

The Nationwide also has a three-year fix at 4 per cent. Northern Rock and the Post Office will both pay 3 per cent on one-year bonds.

If you lock all your money away you are gambling that interest will remain at the current low levels until the end of the term. This is not particularly likely with base rates at 0.5 per cent. When base rate rises, there may be better savings returns available, which you will not be able to cash in on, if you have locked all your cash away.

Outside Isas, the fixed rate bonds are again the most popular with the best of the short-term paying around 3 per cent over one year, three year bonds paying around 4 per cent, including 4.1 per cent at the Dunfermline, and the Yorkshire paying 4.6 per cent over five years.

Icici is an Indian-owned bank, which tops many of the best-buy tables. There have been reports of administrative hiccups, and delays with transfers and passwords. Although investments in Icici are protected in the same way as other investments, the Iceland fiasco has left savers nervous about investing with banks with overseas parents.

Case study

KENNETH Fee, of Rutherglen, Glasgow, has an Isa with the Scottish Building Society, and says he has been "in and out" of all types of accounts in his time.

Now retired, Fee admits to worrying about whether the income from his savings will be sufficient to live on, although it doesn't keep him awake at night.

Fee has other things to preoccupy him at the moment. He is in the middle of a big move, having decided to downsize from his house in Dumbreck to a bungalow in Rutherglen.

He said: "In due course, the move should release some money to add to our savings, but we haven't been able to sell our old property. We have bridging finance to make the move possible.

"I'm aware of the low returns on savings accounts, but it also seems to me that it is not a good time to be buying or selling anything."

Fee is not a customer who has lost trust in his financial institutions. He said: "I've been with the Scottish Building Society for some time, and have always been happy. The account has been handled very efficiently. But I also have a Halifax account, and I could say the same about that."