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“Neither a borrower nor a lender be” — sage advice in Shakespeare’s time, but somewhat out of step with monetary policy today. The lenders and the borrowers are doing just fine as interest rates fall, and cheap mortgages and zero rate credit card deals abound. The plight of savers is the real tragedy.
The Bank of England’s decision to cut interest rates by a further quarter of a per cent is symbolic — it has been more than seven years since the last cut, and until relatively recently, people thought the next movement would be upward.
While the cut itself is small, what it signifies is much bigger. Savers have endured the pain of dwindling interest rates on savings for years, and look set to be stuck with them for even longer, as rising inflation erodes the value of our cash.
Generally speaking, the older you are, the worse it gets. The days when interest from cash savings could boost your retirement income are long gone. Hargreaves Lansdown estimates that since 2008, savers have theoretically lost £160bn worth of interest payments (had rates stayed at 2008 levels).
For those approaching retirement looking to buy secure income stream, the annuities market has never looked more depressing. And workers saving into their pensions and dreaming of retirement may have to dream a little longer. A recent report from McKinsey warned that investment returns could also be “lower for longer” over the next 20 years, implying we’ll have to pay more in to get less back.
So what are prudent savers to do? Last month’s “near miss” on a rate cut prompted me to have a broader review of my savings habits. I have taken three big decisions. Firstly, I have called time on my cash Isa. And after overpaying my mortgage (a lifetime tracker) for years in the expectation that interest rates would go up, I am now reverting to the minimum payment and making a higher pension contribution instead.
Let’s start with the mortgage. After Thursday’s cut, I am in the fortunate position of having an interest rate of less than 1 per cent on my borrowings. This debt is significant, but cheap to service, and rates are unlikely to go up for some time. So down to the minimum repayment it goes.
There is little point putting the cash I stand to recoup every month into a savings account. So I am upping my monthly AVC (additional voluntary contribution) into my company pension instead.
Exploring how much you can put into your pension is well worth doing. The annual allowance (capping what most people can pay in tax efficiently) is £40,000, although this could taper down to just £10,000 if your total income is above £150,000.
Different employers will offer different levels of contribution matching (typically governed by age, or length of service). Firstly, make sure you’re making the maximum contribution for your band. Some generous employers will also match AVCs, up to a certain percentage of your salary. But even if you’re not getting the company shilling, you will still benefit from tax relief at your marginal rate. In simple terms, if higher rate taxpayers make a monthly AVC of £1,000, they will see a reduction of only £600 in their take-home pay.
This could be a doubly advantageous strategy if you earn more than £100,000 a year (at which level, any extra pensions contributions will help claw back the tax-free personal allowance you’re losing).
Of course, pensions are long-term savings, and you won’t be able to unlock the cash until you hit 55. And ask your HR team about the rules — some companies will only let you set up or alter AVCs at certain points in the tax year, or unless a “life-changing event” occurs.
If overpaying your pension is not an option, from next April you can put £20,000 a year tax free into an Isa (and assuming the Lifetime Isa goes ahead, under-40s can also get a 25 per cent government bonus on £4,000 of their allowance).
The vast majority of Isa accounts contain cash not shares, even though stock market returns have vastly outweighed interest rates in recent times. Today’s rate move suggests a stocks and shares Isa is a better bet for medium-term savings (mine has done very nicely since the Brexit vote).
I haven’t paid into my cash Isa for years, but it helps me sleep at night knowing I have enough to pay the mortgage for a year if disaster strikes.
Following the introduction of the personal savings allowance at the last Budget, as a higher rate taxpayer I can earn up to £500 a year in interest before I have to pay any tax. I’d need to have £50,000 in my cash Isa to get anywhere near this level so its tax-sheltering powers are redundant.
For me, the best combination of high interest with (relatively) flexible withdrawals has come through opening a second current account with Nationwide, which — for now — pays 5 per cent on balances up to £2,500, and gives me access to a regular savings product (maximum £500 a month) on the same rate, which my Isa can be gradually siphoned off into.
Both accounts lose their promotional rates in a year, at which point I’ll hunt for another deal. With online applications, mobile banking apps and an array of comparison tools to track down the best deals, it is not difficult to do this. But I suspect the deals on offer one year from now will be far less generous.
Claer Barrett is the editor of FT Money; firstname.lastname@example.org; Twitter: @Claerb
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