Inflation sets savers a tough challengeTop accounts beat CPI but many pay less after tax

15 December 2010


As the official rate of CPI inflation reaches 3.3%, savers who pay basic rate tax need to earn 4.13% to stop the purchasing power of their money falling. Meanwhile, 40% taxpayers will need to earn 5.5% annual interest before tax in order to beat inflation - so finding a best rate savings account is vital.

Inflation persists

Although the Bank of England forecast is for inflation to fall, and the current target is 2%, the most recent consumer prices index (CPI) shows inflation currently stands at 3.3%. At the same time, the long-established retail prices index (RPI) stands at 4.7%. 

The main upward pressures behind November's rates of inflation are food prices (especially wheat-related products such as flour and breakfast cereals), clothing and footwear and furniture. Other items, such as air fares, fuel and lubricants fell.  

UK CPI is higher than that of the EU, which is currently at 2.3%.

Savings rates lag behind inflation   

Bank of England base rate remains at an all-time low of 0.5%, after originally being cut to this level in March 2009. Interest paid to savers has been low over the same period, although the analysts Moneyfacts today reported that 'savings rates in the last six months have been slowly rising, with easy access rates at their highest level since June 2010.' 

However, the firm also commented that even rising rates were 'nowhere near' high enough to combat the effects of inflation.

The impact of tax on your savings

Savers who pay tax on the interest they receive need to earn 4.13% to match inflation if they are basic rate taxpayers.

Although this is possible, it involves a careful search for a top-paying savings account. The majority of savings accounts pay far less, with the average instant access account paying just 0.89%. 

Inflation-beating savings accounts

One way to keep ahead of inflation is to make the most of your tax-free Isa allowance. The best rate cash Isas currently pay between 4% and 4.1%, but to get this you need to lock your money away for four or five years. The best three-year fixed-rate Isas pay between 3.5% and 3.75%. 

For 40% taxpayers, Isas are one of the few ways they can beat inflation. In taxed savings accounts, they would need to earn 5.5% to prevent the purchasing power of their cash from declining.      

If you've used up your Isa allowance and are a standard rate taxpayer, you need to find accounts that pay over 4.13%. The easiest way to do this is to use the Which? saving rates booster, which allows you to shop around and search the market. 

Again, the best rates are generally paid by fixed-rate savings accounts, which require you to lock money away for three, four or five years. The chart-topping 5-year fixed rate accounts currently pay 4.5%.  

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