How much real return are you earning from your bank savings? Any at all?
With interest rates stuck at historic lows, tax rates rising and inflation eroding the value of your savings and income, it is currently extremely difficult to earn a real return from cash.
Too many savers only look at their nominal returns, that is, the amount of interest showing on their bank statement. Those figures are depressing enough at the moment, but it gets much worse when you calculate your real return by deducting tax and inflation from your savings income. There is a good chance that you are actually earning negative real rates of return.
We all want to protect the wealth we have already accumulated, and the only way to achieve this is in ‘real terms’. You therefore have to take inflation and tax into account and plan accordingly. If you have not, you should speak to a wealth manager like Blevins Franks which offers integrated tax and investment planning advice to expatriates.
Anyone still waiting for interest rates to rise in the foreseeable future will be disappointed. In fact, some analysts even think a cut is imminent in Europe.
Looking at the Bank of England base interest rate, currently 0.5%, as at 24th September interest rate futures on money markets forecast that we will have to wait until November 2016 for rates to reach 0.75%. That is four years away.
To make matters worse they also predict a cut to 0.25% next February, to be kept at that level till September 2014.
These predictions can vary significantly from month to month, even from week to week, so it is difficult to base your investment decisions on them. However they do indicate the general sentiment and there is little doubt that any hope of a rise is still some way away. Until the UK economy is safely back on track and showing decent growth rates, which may need the Eurozone crisis to be resolved first, the Bank’s Monetary Policy Committee will be very wary about increasing its base rate.
Interest rates are not much better in Europe. The Euro interest rate is also at a record low of 0.75%, only slightly higher than the UK’s.
The European Central Bank cut it from 1% to 0.75% in July, leaving room for a further reduction if necessary.
Effects of low interest rates
Data from analysts Moneyfacts clearly illustrate the effects of low interest rates.
When the credit crunch started in August 2007, the Bank of England base rate was 5.75%. The typical no-notice UK savings account was paying 4.08%. To earn £100 in interest, before tax, you needed a deposit of £2,451.
Fast forward five years. At the beginning of September, to earn £100 interest from a no-notice account you needed a deposit of £11,111, with the typical no notice account only paying 0.9% interest. Notice accounts pay 1.17%, so you would still need £8,547 to earn £100.
And remember this is before tax and inflation.
Offshore banks are no better. There are much fewer banks competing for customers, so they are under less pressure to offer competitive rates.
Charlotte Beugge of The Telegraph reports that there are really only nine banks competing to offer deals to offshore customers. Five years ago there were at least fifteen, but we have since lost some established names.
To use the UK for an example of the effects of inflation, even though UK inflation has fallen, higher rate taxpayers still need to earn at least 4.18% in interest to earn a real return. Basic rate taxpayers need to earn 3.14%.
The problem here is that, as at mid-September, according to Moneysupermarket there were no easy-access savings accounts that beat inflation for even basic rate taxpayers.
With energy prices, petrol and food all expected to increase over the coming months, inflation may well be on the rise again.
Increases in these costs affect retirees more than the working population, as they have lower income levels. Saga calculated that the cost of living for the over 65s in the UK rose by 22% over the last five years (i.e. since Northern Rock collapsed in September 2007), compared to 16.8% for the population as a whole.
Inflation is an issue wherever you live.
Average inflation for the EU hit 2.7% in August. It has been higher than the 2% target all year.
In some countries it is higher. In Portugal and Malta it was 3.2% and in Cyprus 4.5%.
Do not be complacent about low inflation rates. Over time they still erode the value of your capital, and remember, your personal rate of inflation may easily be higher than the national average.
Bank interest is fully taxable in countries like Spain, France, Portugal and Cyprus, regardless of whether you withdraw it or not. Tax rates are rising, so your earnings are being reduced.
In Spain the minimum rate of taxation for bank interest is 21%, but it can be as high as 27% depending on how much total savings income you earn. This compares to a flat rate of 18% in 2009, regardless of earnings.
In France, this year the combined tax on bank interest (the fixed rate plus social charges) is 39.5%. In 2010 it was 30.3%.
In Portugal, last year the tax rate on bank interest was 20%. It is now 25%, or 30% if your account is in a tax haven (including Jersey, Guernsey, Isle of Man).
In Cyprus the tax rate on bank interest increased from 10% to 15% last year. Although this is still low compared to many other countries, it does mean you are paying 50% more tax. And there is room for the government to increase it when looking to raise more tax revenue.
Speak to an experienced wealth manager like Blevins Franks to discuss wealth preservation strategies for your personal circumstances and objectives.
28th September 2012
The tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual should take personalised advice.