ISA Allowance Up, Savings Rates Down
Although the increases to the ISA allowance are to be received with open arms, there is no getting away from the fact that ISA savers continue to be hammered by low interest rates. At one of the more busy times of the ISA calendar, savers have been dealt a further blow by additional rate cuts, resulting in those who are most organised being hit the hardest. We take a look at recent developments and what the ISA market has to offer, as well as review some of the options being considered in light of the changes announced in the Budget.
Economic latest – interest rates held, inflation down
The Bank of England’s Monetary Policy Committee voted unanimously again this month to keep the Bank’s base rate on hold at 0.5%, which means it has now been at this record low for 62 consecutive months, continuing well into its sixth year.
Better news for savers was that inflation fell to 1.6%, its lowest level since October 2009 and well under the Bank’s 2% target. Inflation has now almost halved from a peak of 2.9% last June.
Another blow to savers as savings rates are cut
However, these two elements of our economy alone do not tell the whole story. The interaction between interest rates, inflation and savings rates is an important one since looking at one without giving consideration to the impact of the other two can be both misleading and costly. Although the reduction to the headline rate of inflation is at first sight great news, this does not necessarily mean savers will automatically benefit.
In fact savers have been dealt another blow as banks are increasingly cutting rates on top Cash ISA deals just weeks into the new tax year with some of the big high street names leading the way. Santander, for example, recently cut its Direct ISA Saver rate for new customers down from 1.6% to 1.2%, a fall of 25%. The bank also cut the rate on its ISA Saver last week now paying 1% on balances of £10,000 (down from 1.5% – a 33% drop) and the rate on £25,000 and over fell by 25% to 1.5% (down from 2%). Even without having to pay tax, none of these rates match inflation.
Nowhere to hide
Since January 2013, there have been over 1700 rate cut announcements to existing savers accounts despite the fact the base rate has remained unchanged during that time. This means that instead of attracting new savers with top rates, banks such as Santander are using their Cash ISA account as a way of luring customers into the latest current account war since it pays current account customers a higher 1.7%.
Fixed rates have also started to fall so there really is nowhere for savers to hide. This trend is also likely to trigger a domino effect across the entire market because as top rates drop, other providers are pushed to the top of the best-buy tables – from this position they attract more money than they want, so in turn they cut their rates to deter savers, or even shut accounts. This is a serious situation for even the most savvy savers.
By cutting rates they are taking advantage of savers at one of the peaks in ISA season around the start of the tax year. These are unprecedented times for savers with falling ISA rates almost immediately after the tax year end being unheard of previously. Usually providers leave their rates untouched to attract early savers for the new tax year but unfortunately we are seeing the lowest ISA rates ever, and at a time when savers are most in need. Banks simply do not want your money.
Interest rate rises unlikely in the near term
Another impact of inflation pulling back for the third month in a row is that it eases any pressure that might be put on the Bank of England to lift interest rates. With the move away from using unemployment figures as a yardstick for potential rate increases, the Bank is now pointing towards a more balanced growth in the wider economy before any suggestion that we are in a sustained recovery within which interest rates might then rise.
This gives the governor of the Bank of England plenty of scope to keep rates low and means there is unlikely to be a hint of a rise until mid-2015 at the very earliest. But even if we do see an increase, whether savings rates will follow such a rise remains to be seen and given the number of rate cuts in the meantime, how long would it actually take for savings rates to return to their previous highs? Perhaps the more important question to consider is will they ever?
The new ISA allowance – Be Prepared…
These savings rate cuts also come just before the amount you can put into a Cash ISA soars. The Cash ISA allowance for this tax year has been £5,940 since 6th April but from 1st July, it rises to £15,000. Also from this date investors can switch from Investment ISAs to Cash ISAs for the first time.
Fortunately then we will have increasing opportunities with the uplift in the ISA allowance along with increased flexibility, however this also means that even more money could end up with banks and building societies as investors look to rebalance ISA portfolios – just at a time when they do not want your money. Rates could also fall again in July when the ISA limit increases.
If you have ever made a decision with your savings which involved relying on interest rates picking up in the next year or two you will know that this can be costly. It has perhaps never been more important to manage your savings carefully, remaining vigilant and not allowing inertia to reward the banks and building societies which drop the interest rates they are paying.
Many variable and fixed rates have fallen by more than half, whilst tax payers still need to earn more than 2% to beat inflation. There are no instant access or notice accounts paying anything near this amount, cash savers will have to commit to a fixed term of at least 18 months in order to match or beat inflation, and this is on the assumption that inflation does not move up from its current levels for the fixed term.
The real risk is doing nothing
The main risk of doing nothing is the impact inflation will have over time. With instant access losing you money in real terms and fixed rate bonds not offering much of a premium for tying up your money, even if you think that inflation could average below the Bank’s 2% target for the coming years, it only takes a small increase and suddenly you could be losing significant amounts in real terms.
Failing to understand the real impact inflation can have on your capital can produce painful results, especially over time. Not only must we ask ourselves what we are buying when committing to a product, we should also be considering what alternatives are available since unfortunately the current market for savers often leads us to a tough decision – either lose money in real terms from a savings account, or take on more risk.
Moving up the risk spectrum
The only alternative to accepting losing money in real terms is to move up the risk spectrum and with the relaxation around the movement between Cash ISAs and Investment ISAs helping to remove some of the cash versus investment ISA debate, there is now an opportunity and a need for savers to really consider their options very carefully indeed.
A middle ground
Instead of making the full leap from cash to investments, structured deposits offer the potential for stock market linked returns but without risking your capital by combining a deposit with an investment where the return is not guaranteed but rather dependent on the performance of some underlying asset, normally the FTSE 100 Index.
The deposit provides the capital protection, whilst linking your return to the stock market replaces a fixed rate of interest with the potential for a higher return. Combined, this provides a product that offers a middle ground between a traditional fixed rate bond, where your capital and return is guaranteed, and an investment where your return is not guaranteed and your capital is at risk.
Rise in popularity
There is a wide choice of product types covering both income and growth and ranging from 3 to 6 year terms although some can mature early from year 2 onwards. Deposit status also means that these plans are eligible for the Financial Services Compensation Scheme which offers protection up to £85,000 per individual, per institution.
One of the major factors leading to an increase in the use of such alternatives has been the over-reliance of fixed rate bonds by savers who are now seeing the real value of their savings eroded at a time when they need it most. Structured deposits combine capital protection with the potential to receive higher rates than are currently available from fixed rate bonds, and even to beat inflation.
Defined return, defined risk
For those looking for the potential for higher returns and who are prepared to put their capital at risk, the choice of investments available is vast. Our most popular investments are fixed term investment plans offering a defined return for a defined level of risk, which means you know exactly what has to happen in order to achieve the stated returns on offer.
The investments are designed to provide either income or growth and normally have a fixed return but like structured deposits, some have the ability to mature early. Some also have a defensive element which means you can achieve high returns even if the stock market goes down slightly.
Income plans have proved most popular with our investors, including a unique fixed income plan which offers a high level of fixed income for a fixed term so investors know exactly how much they will receive, when and for how long.
Some capital protection against a falling market
These investments also include what is known as conditional capital protection which means that your initial capital is returned at the end of the investment term, as long as the FTSE has not fallen below a specific level (e.g. 3,900 points) or a percentage, normally 50% of its value at the start of the investment. These plans therefore offer some capital protection against a falling stock market. Your capital will be at risk if the Index does fall below the defined level, in which case your initial capital will be reduced by 1% for each 1% fall and so you could lose some or all of your initial investment.
No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. If you are at all unsure of the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice. Tax treatment of ISAs depends on your individual circumstances and is based on current law which may be subject to change in the future. Always remember to check whether any charges apply before transferring or switching an ISA.
Structured deposit plans are capital protected. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In this event you may be entitled to compensation from the Financial Services Compensation Scheme (FSCS), depending on your individual circumstances. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.
Structured investment plans are not capital protected and are not covered by the Financial Services Compensation Scheme (FSCS) for default alone. There is a risk of losing some or all of your initial investment. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.