Beware of savings accounts promising inflation-busting returns

By Staff Writer Ruth Jackson Feb 22, 2011

Ruth Jackson

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Do you remember when saving had a touch of joy to it? You earned money. You put it away. Then, when you checked your account a year later you found you had more than you started with. Sadly, those days have gone. Sure, there might be a few more pennies in your account at the end of the year than the start. But they won't buy you more than your original stash would have. Instead, they'll buy you less.

With inflation now at 5.1%, according to the Retail Price Index (RPI), you need to be getting an interest rate of at least 6.38% (8.5% if you are a 40% taxpayer) in order to see the purchasing power of your money actually increase after inflation and tax are taken into account. That hasn't been easy: the best rate on offer has been 4.85% with Principality Building Society (and to get that you have to lock your money away for five years).

However things are now beginning to look better: Birmingham Midshires, the Yorkshire Building Society and the Post Office have all launched new inflation-linked bonds. These sound good. They offer a rate of return that is pegged to the RPI. So your money grows a little bit in real terms no matter how high inflation gets.

That's the good news. The bad? Not all the accounts are as good as they appear, so make sure you read the small print. The Yorkshire Building Society account, for example, should be avoided. Its Protected Capital Account pays you either the annual RPI change in the year to each March, plus 0.10% on their annual interest account or, on their maturity account you get the change in RPI between 2011 and 2016 plus 0.10%. Adding just 0.1% to the rate of inflation means that your money won't beat inflation after tax. Instead you'll always just be lagging behind - meaning your savings will always be shrinking in this account in terms of purchasing power after tax has been deducted.

You can also access either product as a cash Isa so your returns won't be taxed. That doesn't sound too bad but there is a problem; inflation doesn't always increase. If the account had existed in 2009 you'd have got an annual rate of just 0.1% because inflation fell that year. Yorkshire Building Society promises your capital is protected so if inflation falls you will still get the 0.1% rate but that is pitiful. Invest in this account for five years and you are taking a gamble by pegging your interest rate to a bet that inflation will rise.

The accounts offered by Birmingham Midshires and the Post Office are more enticing. Both of these pay you the actual RPI rate plus a a larger percentage. The Birmingham Midshires account pays RPI (calculated each January) plus 0.25% so this year that would mean an interest rate of 5.35%. The Post Office will pay RPI (calculated each April) plus an impressive 1.5%, which works out at 6.6% (using January's RPI figure). So the Post Office is offering the only account on the market that beats RPI (although only for basic rate taxpayers). The only problem with the account is that you have to lock your money away for five years. Over that period inflation could fall and interest rates are likely to rise so it may not remain the most competitive account on the market. But a guaranteed inflation hedge for the next five years shouldn't be sniffed at.

Inflation-busting alternatives

At present the Post Office offers the only way to beat inflation but there are two other inflation heroes on the horizon. Firstly, individual savings accounts (Isas) could offer a respite to savers. With a cash Isa you don't pay any tax on the interest you earn so you just need an interest rate to beat inflation (5.1% at the moment). While that rate isn't available right now, Isa season is just getting into swing and most of the big providers have yet to release their new accounts. So keep an eye out for good deals over the coming weeks.

Secondly, in April National Savings & Investments (NS&I) will review the situation regarding its index-linked savings certificates. These accounts pay a tax-free return guaranteed to beat RPI over a fixed term. They were withdrawn from sale last July when rising inflation meant they were getting too popular. (As a government-backed scheme NS&I isn't allowed to produce products the banks can't compete with and these certificates were too good.) If they do return to the market in April they will be snapped up fast so make sure you keep an eye out. I'll keep you updated on NS&I and the best Isa deals here and via my Twitter account @RuthMoneyWeek.

But for now I'd be beating a path to the Post Office.

Comments (8)

Published in Savings | More articles by Ruth Jackson

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  • 1. Dick

    (22 February 2011, 03:43PM)  Complain about this comment

    Isn't there an issue with the post office? That is, it is Bank of Ireland and as such is only partially guaranteed by the FSA, the balance being guaranteed by the Irish Government, which is going through a very rocky patch?

  • 2. Andy

    (22 February 2011, 03:59PM)  Complain about this comment

    NS& I index linked savings certificates as a government backed scheme.
    What are the chances that CPI, the governments chosen measure of inflation will be used as the index to link these certificates to?
    The government has only just restored the earnings link to the state pension so it has to fund the unfunded somehow!

  • 3. Jon Dickins

    (22 February 2011, 04:47PM)  Complain about this comment

    Dick - Post Office accounts with Bank of Ireland are now covered by FSCS.

  • 4. Nick

    (23 February 2011, 09:31AM)  Complain about this comment

    You warn of accounts promising inflation-busting returns and then advertise a product that claims:

    (Here’s a PROVEN way you could make money from the markets for the rest of your life).

    Which is evidently untrue.

  • 5. sash

    (23 February 2011, 11:19AM)  Complain about this comment

    I have sold my house have £640,000 to now live on for the next 10 years. I am 80. I want to put it somewhere safe but will have to live off some of the interest. Look forward to hearing from you.

  • 6. Brian

    (23 February 2011, 11:55AM)  Complain about this comment

    Infrastructure funds such as HICL also offer a hedge on inflation since the PFI scheme payments it receives are index linked but your capital is not guaranteed as with NSI.

  • 7. H

    (23 February 2011, 04:25PM)  Complain about this comment

    "Not all the accounts are as good as they appear, so make sure you read the small print. The Yorkshire Building Society account , for example, should be avoided. Its Protected Capital Account pays you either the annual RPI change in the year to each March, plus 0.10% on their annual interest account or, on their maturity account you get the change in RPI between 2011 and 2016 plus 0.10%. The key word here is 'change'. "

    WHAT IS THE ISSUE WITH "The key word here is 'change'?"

  • 8. RKS

    (01 March 2011, 03:16PM)  Complain about this comment

    Everyone seems to be missing the crucial point about these new "inflation busting" products. Take the new Post Office account....it only pays inflation on your ORIGINAL capital over 5 years. Therefore, if inflation is 6% a year over the 5 year term, you get 7.5% each year on your original outlay. Spot the problem? Inflation is eating away at your original capital each and every year of the 5 year term!! Even worse you must take off income tax (assuming majority of savers would be tax payers). Moneyweek should be highlighting this as a major flaw and people should stay away. This is not an inflation busting product. And this is the Post Office - a governement owned body. What chance does the public have in keeping the value of its savings safe?

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