Inflation: What you can do to beat it – but only just

13th September 2011

The Office for National Statistics has published August's cost-of-living data.

CPI annual inflation – which is the Government’s target measure – was 4.5% in August, up from 4.4% in July while RPI annual inflation was 5.2% in August, up from 5% in July.

Energy bills were blamed for part of the hike. The Daily Mail reports that energy bills increased by 5.1% over the year, having stayed the same the 12 months ending August 2010.

Other pressures on family finances came from clothing and footwear, where prices overall rose by 3.7 per cent between July and August compared with a rise of 2.8 per cent between the same two months a year ago.

The cost of furniture, household equipment and maintenance also rose, these by 2% over the month compared with a 1% rise a year ago.

Moneyfacts, a ratings website used by savers, probably stated the obvious in pointing out the figures were bad news. 

To beat inflation it estimates that a basic-rate taxpayer at 20% needs to find a savings account paying 5.63% per annum, while a higher rate taxpayer at 40% needs to find an account paying at least 7.50%.

Moneyfacts says there are currently five accounts that negate the effects of tax and inflation, all of which are fixed-rate ISAs. However, there is not a single account available that beats RPI at 5.2 per cent.

The effect of inflation on savings means that £10,000 invested five years ago, allowing for average interest and tax at 20 per cent, would have the spending power of just £9,345 today.

Sylvia Waycot, spokesperson for Moneyfacts, says: "Today's rate of inflation means hundreds of thousands of savers need accounts paying a staggering 7.50 per cent before they earn a real rate of return on their savings.

"Anything less means they will fall into ‘the eroding spending power trap' which has already wiped £655 off the spending power of £10,000 in just five years."

For those about to retire, and considering purchasing an annuity, or income for life, Tom McPhail, head of pensions research at Hargreaves Lansdown has the following advice.

"For a 65 year old man with £100,000, there were three choices. A single life annuity with a five year guarantee paying £6,066 a year, a fixed increase (set at 3%) paying £4,137 or an RPI linked annuity paying £3,723 a year.

McPhail calculates how based on a cohort (those in the same peer group) life expectancy of 21.6 years, the retiree would be better off buying the RPI linked annuity but only if inflation runs at 4.6% or higher year on year for the rest of his life.

This is because the cumulative value of the 3% annuity payments will overtake the level annuity after 24 years.

McPhail urges those about to buy annuity to seek independent advice as soon as possible.

"Investors shouldn't ignore the inflation risk. They should look to build some inflation proofing into their retirement income. There is nothing to stop investors splitting their pension fund, buying some level income and some increasing income. Whatever else they do, they should shop around to make sure they are getting the best possible deal with the money they have built up in their pension."


Investing: Where have all the safe havens gone?

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