Interest rate hike means savers are damned if they do, damned if they don't

Becky O’Connor, Head of Pensions and Savings at interactive investor,considers the impact of today's 0.25% increase in interest rates to 0.75% forsavers, ISA and pension investors.

On the face of it a rate rise of 0.25% to 0.75% looks good for savers, but high inflation spoils the party.

Savers and investors are damned if they do and damned if they don’t. Every option seems to have a downside. Decisions on where to keep money may ultimately come down to what looks like the least bad option.

People can either leave their money at the mercy of inflation in savings, or in investments at the mercy of global stock market volatility, caused among other things by rising inflation and interest rates coming together. Neither seems particularly appealing if you are trying to preserve and grow the value of your hard-earned money.

But leaving spare cash in a current account rather than in savings or investments isn't an answer - it will be eroded by inflation there too. Residential property, in the past a popular alternative investment, looks historically relatively expensive and returns from buy to let are being eroded by higher tax bills and the cost of improving energy efficiency.

The tax relief ‘perk of pensions’

The tax relief perk on pensions could come into its own. It is a saving grace for people looking for a long-term home for their money with a decent prospect of some uplift above inflation over the long term, giving an instant head start on the value of money going into a pension.

For basic rate taxpayers, contributions get an instant 20% boost in the form of tax relief, so an £80 contribution becomes £100. For higher rate taxpayers, a contribution is 40% tax relief, so a £60 contribution becomes £100.

There is no other tax benefit on an investment vehicle available to the masses that will instantly give you a protective buffer against inflation like this.

If you are lucky enough to have some spare cash, then you could do far worse than adding it to your pension in your quest to beat inflation - provided you can wait til you are at least 55 to access it.

Cash savings

The rate on a savings account has almost become a meaningless detail in the face of such rampant inflation. This rise might make those who prefer saving to investing feel a little less ripped off, but it’s still incredibly difficult to justify keeping more money than necessary in cash, where it is being overwhelmed by inflation.

It is particularly important for those with larger cash balances, such as retirees or those close to retirement, to consider the real return on their savings.

If you can’t avoid cash, find the best possible rate. If you can put your money to work for the long term, go for investments, either in ISAs or pensions, choosing growth or income options depending on what you need the money for.

Stocks and Shares ISAs as an alternative to cash

There is still time before the end of the tax year to put any money currently in cash you don’t need into an ISA, which offers tax-free growth on up to £20,000 a year, or your pension, which offers up to £40,000 a year or up to your annual earnings, whichever is lower.

Remember if you are retired and already drawing an income from a pension, you can still contribute up to £4,000 a year into it without facing a tax charge. You will still get tax relief on these contributions at your current income tax rate.

For retirees and those close to retirement

Higher interest rates might negatively impact your pension fund value, depending on what it is invested in. Meanwhile, higher inflation is likely to be adding to pressure to withdraw more and also reducing the buying power of your pot.

You might consider looking at annuity rates to see if higher interest rates have made these a more appealing option for you than income drawdown at your 'sustainable withdrawal rate'. This is becoming more of a possibility, after years of annuities looking distinctly unappealing. However it does mean you would be on a fixed income in a time of rising inflation, depending on rises in any state pension you receive to keep your living standards even.