There has never been a more important time to make sure your savings are working as hard as possible.
Inflation is running riot, interest rates paid on savings are too low, and Vladimir Putin’s war in Ukraine is causing stock market chaos.
We also face the worst cost-of-living crisis in 50 years, with energy bills set to soar to an average of £ 2,000 a year from next month and food prices rising. A new National Insurance levy will cost households hundreds of pounds a year.
Shelter from the storm: Individual Savings Accounts allow UK residents to stash away as much as £ 20,000 in a single tax year – and pay no tax on interest paid and returns
Isas have long protected savings from tax charges, but can they now help to shelter them from the big squeeze, too?
Isa season is upon us and savers have until the end of the tax year, April 5, to use their annual allowance.
Individual Savings Accounts (Isas) allow UK residents to stash away as much as £ 20,000 in a single tax year – and pay no tax on interest paid and returns. It is 23 years since their launch and they hold more than £ 600 billion of our savings.
Jason Hollands, of wealth manager Tilney, says: ‘Savers are facing a squeeze, with inflation expected to surge past 7 per cent by Easter and the tax burden set to rise through a combination of frozen personal allowances and increases in National Insurance and dividend tax rates.
‘It’s vital that everyone who has worked hard for their money does what they can to protect it from inflation and the clutches of the tax man.’
Laura Suter, head of personal finance at investment broker AJ Bell, says: ‘Rising prices and wages failing to rise by as much as inflation mean many households will have no spare money, or will be dipping into savings to meet monthly costs.
‘But wealthier households may be using their spare cash to splurge after the pandemic, booking a pricier holiday or treating their family.’
On top of the National Insurance hike of 1.25 percentage points, Chancellor Rishi Sunak has frozen a series of tax thresholds. It means as wages and savings rise to keep up with inflation, more tax will have to be paid.
Thresholds have been frozen on income tax, capital gains, inheritance and the pension saving lifetime allowance.
A rise in dividend tax will also cost investors more than £ 3billion over the next five years.
The 1.25 percentage point increase in dividend tax will hit about 2.5 million savers (who receive dividend payments of more than £ 2,000) by an average £ 355 a year. But the good news is, if your investments are sheltered in an investment Isa you do not have to pay tax on any gains.
Cash or stocks?
There are big decisions to be made. The average rate paid on a cash Isa is just 0.31 per cent, according to the Bank of England. That will pay £ 31 a year on £ 10,000.
Experts all recommend savers have at least three months’ worth of outgoings put aside in a cash savings account – as emergency money for when the big squeeze starts to bite. But anything beyond that could earn more if it were invested.
Inflation is predicted to soar above even 8 per cent next month. Rising prices mean that the billions of pounds sat in accounts that pay next to nothing in interest is being eroded away in value.
In fact, £ 10,000 saved in the average cash Isa today could be worth just £ 9,600 in a year.
Latest HMRC data reveals that 13 million adult Isas were subscribed to in 2019/20, of which three-quarters were cash Isas.
Latest HMRC data reveals that 13 million adult Isas were subscribed to in 2019/20, of which three-quarters were cash Isas
Many households managed to save during the Covid lockdowns, but much of that money is still sitting in low-interest accounts.
Indeed, rampant inflation and record-low interest rates have pushed the real returns on cash Isas to the lowest level for more than a decade, according to analysis from Quilter.
The wealth management firm says savers now face a historic real-terms loss of 5.3 per cent on cash Isa deposits – nearly twice the previous highest loss of 2.81 per cent in 2017.
So it might be worth trying a stocks and shares Isa to get a better rate of return.
For £ 10,000 invested in the average global stocks and shares Isa over the past decade would now be worth £ 26,402 – even after inflation.
Yet cash Isa rates are starting to creep up. The Bank of England had held the base rate at 0.1 per cent since the start of the pandemic, until a recent hike to 0.5 per cent. It is now standing at 0.75 per cent.
And with rates finally rising, savers can shop around to find the best deal for their nest egg.
Rates to rise?
Interest rates paid on savings accounts, including cash Isas, have been stubbornly low for years now. And the recent uptick in the base rate has done little to change things – so far.
Savers pulled a record £ 7 billion from cash Isas in the last six months of 2021 – the highest amount withdrawn since then Chancellor Gordon Brown launched the accounts in 1999.
It came after interest rates on cash Isas more than halved last year to hit an average 0.3 per cent in December.
Last month, the average rate paid on a cash Isa was 0.26 per cent, only a little higher than the average 0.21 per cent paid on easy-access savings accounts.
Exit: Savers pulled a record £ 7bn from cash Isas in the last six months of 2021 – the highest amount withdrawn since then Chancellor Gordon Brown launched the accounts in 1999
Yet the Bank of England has forecast the base rate could rise to 2 per cent within a year.
Cash Isas have dwindled in popularity since the personal savings allowance was introduced in 2016, meaning basic rate income tax-paying savers in the UK did not pay tax on the first £ 1,000 earned in interest.
But Ms Suter, of AJ Bell, says: ‘We’ve already seen providers increase their rates, and savers will see more increases before the end of the year. This means that more people will start to hit their Personal Savings Allowance, so a cash Isa will become more appealing.
‘People should also consider that you can transfer a cash Isa into a stocks and shares Isa at any point.
So while the tax-free status might not look that valuable on cash savings, if you save money within an Isa you have the option of investing it in the stock market in later years and the tax benefits then become very valuable. ‘
While cash Isa rates may be due a rise, they still do not stand a chance against high inflation.
Ms Suter adds: ‘Fears of savings being eaten away by inflation is top of investors’ list of worries now, which will inevitably have an impact on how savers invest their money this tax year end.
‘Inflation is the enemy of cash, as no cash Isa account comes anywhere near the current rate of inflation, let alone what it’s going to peak at this year.’
She says this means savers should only have emergency savings in cash. Any that doesn’t need to be touched for at least five years could be put to better use in an investment Isa.
But where do you start when looking for an investment fund to beat (or at least come close to) inflation?
Ms Suter likes Personal Assets Investment Trust, which turned £ 10,000 into £ 12,300 over five years.
Cost of living crisis: Cash Isa rates may be raising, but they stand little chance against soaring inflation which is set to hit 7% by Easter
It holds gold and inflation-linked bonds, plus firms such as Microsoft and Visa. She also tips First Sentier Global Listed Infrastructure, which has turned £ 10,000 into £ 13,509 in five years.
Kate Marshall, Hargreaves Lansdown’s lead investment analyst, likes global fund Troy Trojan, which turned £ 10,000 into £ 13,002 over five years.
She says: ‘The fund’s investment objective is to grow investors’ capital (net of fees) ahead of inflation over the long term, as measured by the UK Retail Prices Index.
‘Manager Sebastian Lyon aims to shelter investors’ wealth just as much as grow it.’ The fund contains large, established firms that will grow sustainably and likely weather any tough economic conditions. It also contains bonds, gold and cash.
Ms Marshall also likes Pyrford Global Total Return fund, which has turned £ 10,000 into £ 10,830 over five years.
She adds: ‘Fund manager Tony Cousins and the Pyrford team have three key aims: Not to lose money over a 12-month period; to deliver an inflation-beating return over the long term; and to do this with low volatility – fewer significant ups and downs in value than a fund invested entirely in shares. ‘
This year has already given investors a rollercoaster ride – with popular tech stocks falling in value and then the war in Ukraine causing markets to fall across the world.
So how should savers invest given the perilous geopolitical outlook, and the prospect of rising inflation?
Emma-Lou Montgomery, Fidelity International’s associate director for personal investing, says savers could benefit from making small deposits regularly.
She says: ‘Now is the time to take a slow and steady approach to your savings and investment goals. An Isa is a great way to do this, giving you the ability to drip-feed small, regular sums into your savings pot, which might be particularly appealing right now.
‘With a stocks and shares Isa, you can set up a regular savings plan from just £ 25 a month.
‘This enables you to access the full range of investments available, while taking away the task of working out the’ best time ‘to invest. Key to investing is a long-term view, rather than getting caught up in the here and now. ‘
She also suggests new investors consider what they pay for their funds. Those run by a fund manager charge more.
She says: ‘Rather than being actively run by a manager, passive funds simply emulate or track an index. Costs can be much lower. However, they’ll match rather than outperform the market. ‘
But she adds: ‘The beauty of a stocks and shares Isa is that you can pick and choose what you invest in.
‘So as your confidence grows, you can throw some actively managed funds into the mix, as you choose.
‘The key to investing is to build a diverse portfolio with a mix of investments that suit your attitude to risk. A balanced investment portfolio might have in it individual stocks, funds, property, commodities, bonds and cash, for example. ‘
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