Cash Isas are more valuable than they have been for years —and not just because there are generous rates on offer.
Good rates are all well and good: but if they are lower than inflation, the value of your nest egg will still be eroded over time.
For years, it has been impossible to beat inflation but today, according to rates scrutineer Savings Champion, there are 286 Isas that pay more than 4 per cent — the rate at which consumer prices rose in the year to January.
This time last year the best instant access Isa paid 3.01 per cent in interest, so you would have earned £30 on £1,000 if you had left your money in the account for the past year.
However, the cost of goods has risen by 4 per cent over that same period, so your savings would now be able to buy only £991 worth of goods.
Inflation heroes: There are currently 286 Isas that pay more than 4% – the rate at which consumer prices rose in the year to January
Over the past ten years, inflation has averaged 3.44 per cent a year. That means £1,000 saved in 2014 would need to have grown to £1,400 by 2024 just to maintain the same purchasing power.
Although you can beat inflation today, you still have to work for it.
Anna Bowes, of Savings Champion, says: ‘Of course, there is a huge discrepancy between the best rates and the worst, so it’s important to shop around.’
While the best cash Isa rates pay far more than inflation, there are plenty that still pay a pittance.
Ms Bowes says: ‘Lloyds Bank is paying just 1.40 per cent on one of its accounts. On a balance of £10,000, inflation will erode the value of the cash over time in this poor-paying account.
‘After five years, assuming that inflation were to remain at 4 pc and you were earning 1.4 per cent, although the balance would have grown to £10,720, including the accrued interest, the real value after the effect of inflation would have fallen to £8,811.’
It is crucial you make sure your savings are not steadily eroded by inflation by carefully choosing a home for your savings.
For example, if you put your money into Moneybox’s market-leading instant access cash Isa, paying 5.11 per cent, your £10,000 would have earned £2,830 in interest and the real value — when you factor in inflation — would have also grown to £10,545.
This account accepts transfers from other Isas, so you can shift any money that is sitting in old Isas with poor interest rates. It has a minimum opening balance of £500 and must be operated via an app.
If you are happier with online banking, then Virgin Money is paying 5.06 per cent on its Defined Access Cash Isa — but you can make only three withdrawals a year before the interest rate drops.
If you are prepared to lock your money away for 12 months, then you can get a rate of 5.25 per cent from Virgin Money.
If you lock into a fixed-term Isa, you are likely to be offered a lower interest rate than on the best easy-access accounts.
Over the past ten years, inflation has averaged 3.44% a year. That means £1,000 saved in 2014 would need to have grown to £1,400 by 2024 just to maintain the same purchasing power
This is because banks and building societies are anticipating that the Bank of England base rate will fall before the end of the term, so they don’t want to be caught out offering a significantly higher interest rate for years to come.
However, if you don’t need to access your cash in the short-term, a fixed-rate cash Isa could be a great way to beat inflation.
That is because you can currently get rates that both beat today’s inflation rate and are likely to significantly outperform the inflation forecasts made by experts.
The Office for Budget Responsibility (OBR) currently expects inflation to fall to an average of 2.2 per cent this year and 1.5 per cent in 2025, before gradually returning to the Bank of England’s target of 2 per cent.
Aldermore is offering a top three-year cash Isa at 4.5 per cent. If the OBR forecast proves correct, you could be earning 4.5 per cent interest next year while inflation is just 1.5 per cent, amounting to a real return of 3 per cent.
Cash Isas tend to be far better at beating inflation than standard savings accounts.
That is because if you have a substantial sum in a savings account, you risk being taxed on earnings you make on top of facing the ravages of inflation.
If you are a basic-rate taxpayer, you get a personal savings allowance of £1,000 a year.
In the past, you didn’t have to really worry about paying tax on your savings as interest rates were so low that you needed to have huge sums in the bank to earn more than £1,000 in interest.
But as interest rates have surged, just £20,000 in the top-paying accounts would generate more than £1,000 in interest in a year.
Secondly, more and more of us are being dragged into higher income tax brackets due to the frozen thresholds.
If you become a higher-rate taxpayer, then your savings allowance is halved to £500. Additional rate taxpayers lose their allowance entirely.
This means you could start paying tax on your savings income overnight.
