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What does inflation mean for your savings?

Category: Savings
Author: Tim Leonard
Updated: 16/01/2018

High inflation can be a nightmare for savers, particularly when coupled with low savings interest rates.

In this guide we're going to look at:

  1. What is inflation?
  2. Rate of inflation
  3. The effect inflation has on savings returns
  4. How you can protect your savings from inflation

What is inflation?

Inflation is simply to do with how much your money can buy.

Think about 10 years ago…

  • How much did a loaf of bread cost?
  • Or a pint of milk?

In all likelihood it cost less in pounds and pence than it does now: that's the effect of inflation.

Rate of inflation

If a pint of milk was 48p this time last year and 50p now, you could say that the annual rate of inflation on a pint of milk was just over 4%. If you then expanded that to measure the changes in price of lots of goods and services, you could see how the cost of living in general is going up, or coming down.

That's basically what the rate of inflation does. In the UK we have two main inflation rates: the Consumer Price Index (CPI) and the Retail Price Index (RPI).

The two measures of inflation are different because they measure a slightly different 'basket' of goods and services. For example, RPI includes housing costs such as mortgage interest, rent and council tax. They are also different because they are calculated in a slightly different way.

What is the effect of inflation on savings?

In order for your money to be 'worth' the same amount, you will need the income you receive (in wages, pension, etc.) to increase by at least the rate of inflation each year.

Similarly, any 'stored' wealth you have, such as your home (if you own it) or money you have invested, will need to grow by at least the rate of inflation, too. If it doesn't, your money will be losing value in real terms.

Savings accounts are also subject to interest rates. If the rate of inflation is high and you are receiving a low interest rate, you could find it difficult, or even impossible, to beat inflation.

The rule is simple:

"After tax, the rate of interest you earn on your savings must be greater than the rate of inflation, in order for your money to actually be growing."

The other thing to consider is how much of your interest you're taxed before you ever receive it. From April 2016, you can earn up to £1,000 in interest each year tax-free (if you are a basic rate taxpayer). If you earn over this you will need to pay tax, which further reduces the value of your savings. In order to just equal inflation, you'd need to earn the following rate of interest on your savings account:

Equivalent gross savings rate needed to equal the rate of inflation…
Inflation Rate Basic Rate Taxpayer Higher Rate Taxpayer Additional Rate Taxpayer





























What can you do to inflation-proof your savings?

  • Use your cash ISA allowance

You have an allowance to put in a cash ISA each tax year. The interest you earn is tax-free, providing you with a massive boost in the fight against inflation. From April 2016, basic rate taxpayers earn up to £1,000 of savings interest each year without having to pay any tax on it, so the main distinguishing feature of ISAs is not so obvious. However, if you are planning to amass a considerable savings pot, you will at some point likely breach the personal savings allowance, which is where ISAs can shine.

  • Review your savings rate regularly

Keeping your savings in a top-paying account is a major way you can beat inflation. Older savings accounts (particularly those that initially included an enticing introductory bonus) may not be working as hard as they should be.

Conducting an annual review of your savings interest rates will help you take action on lower-paying accounts and give your savings a better chance of battling the effects of inflation.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.