What Impact Will Inflation Have On Your Savings?


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Inflation in the UK has hit a shocking 5.2% and it is also above target in the Eurozone. We all need to be aware of the detrimental impact inflation can have on our savings and incom

Inflation in the UK has hit a shocking 5.2% and it is also above target in the Eurozone. We all need to be aware of the detrimental impact inflation can have on our savings and income, particularly if you are retired. If you ignore the inflation threat you run the very real risk of losing spending power year after year.

As announced in mid-October, the UK?s Consumer Price Index (CPI) rose from 4.5% in August to 5.2% in September ? a larger rise than expected. Inflation is now considerably above the Bank of England?s (BoE) target of 2%.

Cash savers have had nothing but bad news for a number of years now. High inflation at the same time as low interest rates is their worst possible scenario as it usually means they are losing money in real terms.

Financial information provider Moneyfacts says there are now no regular savings accounts beating inflation at the moment. A UK basic rate taxpayer paying tax at 20% now needs to earn 6.5% on their bank savings to beat inflation, while higher rate taxpayers paying tax at 40% need to earn 8.67%.

With the BoE base rate at just 0.5% and no hope for an increase in the foreseeable future, obtaining such rates seems rather a pipe dream at the moment.

The UK economist at ING Bank, James Knightley, believes savers may have to wait until 2014 before they can earn returns that beat inflation.

High inflation is a particular concern for retired people as it can be very detrimental to their long-term wealth, and therefore standard of living.

Retirees living on fixed incomes suffer the biggest drop in real spending power. Anyone who bought a fixed-rate annuity is continuing to receive the same amount of income each month, even though it can buy them less and less. They will find it harder to meet their living expenses as the years go by.

The biggest upward pressure on UK inflation in September came from gas (up 13%) and electricity (up 7.5%). Since retired people tend to spend more time at home they are most affected by rising heating and electricity prices.

Pension provider Standard Life has calculated that a 90-year old who retired in 1981 has seen the purchasing power of ?10,000 a year fall to just ?3,207 today.

While the UK is suffering higher inflation than the EU?s, this does not mean we can be complacent here in Europe. The EU average HICP (Harmonised Index of Consumer Prices) was 3.3% in September.

Looking at the electricity and gas prices that affect retired people, the UK is not alone in seeing large increases. Compared to September 2010, electricity increased 17.7% in Cyprus; 14.4% in Spain and 6.1% in France. Gas prices shot up in a number of countries, with Malta seeing a 25.5% increase; Cyprus 24.2%; Spain 15.3%; Portugal 10.9% and France 6.4%.

It looks like we may have to get used to higher electricity prices too. A Financial Times article on 16th October covered a leaked European Commission report on how the EU can meet its green energy targets. The report reveals that European households and businesses face at least 20 years of rising electricity prices. Average prices would ?rise strongly up to 2020-2030? under all scenarios, with the highest prices occurring after 2030 if most electricity is then produced by renewable sources of power, such as wind and solar.

While many people choose to keep money in the bank in order to avoid any investment risk, they often do not realise that keeping cash long-term is also risky in terms of the damage inflation can do to their wealth and spending power over the longer-term.

Periods of high inflation and low interest rates increase this risk, but even lower inflation will have an impact on your savings over the years.

Let?s say that inflation is 2.5% over the next 20 years. Within five years the spending power of ?100,000 will reduce to ?88,109. After 10 years it is ?77,632 and after 20 years it is down to just ?60,269 ? a 40% loss in spending power, just at the time you may have increased medical or care costs.

Consumer price indices aim to measure the changes in the price of goods and services commonly purchased by the average family and are based on a large ?basket of goods?. Your personal rate of inflation could be different from the CPI rate if your spending differs from the average.

If your personal rate of inflation is 4%, ?100,000 is reduced to ?66,483 after 10 years and right down to ?44,200 after 20 years.

If you have savings which you are planning to hold for the future, you need to invest them if you are to stand any chance of preserving their value and spending power. Don?t let your retirement savings suffer unnecessary nominal losses because of neglect – the retirement planning you set up years ago may no longer be suitable and should be reviewed every year or so. Your asset allocation strategy should always be consistent with your current needs and aspirations.

Admittedly the recent uncertainty and volatility does not make this the easiest time to invest if you are concerned about capital values falling, but the spending power of your bank savings also falls over time.

This actually can be a good time to be buying shares as many are depressed bargains available after the recent falls. There is also an opportunity to buy corporate bonds at lower prices and lock in a higher rate of interest, helping provide income above the rates of inflation.

You should talk to an experienced wealth manager like Blevins Franks Financial Management Ltd. to discuss investment strategies that you would feel comfortable with. You also need to review your tax planning, because with inflation reducing your spending power you want to ensure that you do not lose any more of it to taxation than absolutely necessary.

By Bill Blevins, Managing Director, Blevins Franks

31st October 2011

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; individuals should seek personalised advice.