How does inflation erode your savings? And what you can do to beat rising rates

Purchasing power of cash savings will be badly hit if inflation remains at current levels for prolonged periods of time and number crunchers have shown by just how much.

Inflation soared to 9.1 per cent in May, with predictions it will peak at 11 per cent later this year. 

New analysis from Standard Life shows that as savers battle rising household bills and climbing cost of food and transport, the decreasing purchasing power of their money is exacerbating the cost-of-living crisis.

Inflation sap: £10,000 in savings earning 1.5% would having purchasing power of just £8,910 after a two-year period of 7% inflation

For example, £10,000 in savings earning 1.5 per cent in interest would drop in buying power to just £8,910 after a two-year period of 7 per cent inflation.

In contrast, if inflation was 2 per cent, the Bank of England’s target level, after two years the same amount would have a purchasing power of £9,894. 

As a result savers are at risk of seeing their money erode in value quickly if the current situation lasts.

Jenny Holt, managing director for customer savings and investments at Standard Life said: ‘Most people have been feeling the effects of rising prices over the last few months, as fuel, energy and food costs surge. 

‘Unfortunately, the Bank of England is predicting inflation rates will peak later in the year, potentially reaching 11 per cent, and this not only affects your regular income, but hard-earned cash-based savings will be impacted too as its purchasing power is reduced. 

‘It’s therefore especially important to make sure that the money you have saved and can save is working as hard as it can for you and your future.’

In recent months, there has been a boost to savings rates off the back of the base rate hikes. However, the gap between the best buys and inflation is incredibly wide. 

Currently, the best easy-access account pays 1.56 per cent – some 7.54 per cent below inflation, while the best two year fix pays 3 per cent, or 6.1 per cent below inflation.

However, many high street banks continue to pay just 0.1 per cent or even less. This is a 9 per cent gap on inflation. 

Six steps to make your savings work harder 

Standard Life has outlined six steps people can take to make their savings work harder

First, they should revisit their financial goals in light of the impact of inflation on your savings. Do the economic circumstances mean that they have to change?

Second, it may be worth reviewing your direct debits. 

Many of us have memberships and subscriptions that we could probably live without, so have a think whether you could cancel them or look around for a better deal. 

You might be surprised at how much money you could save.

Third, prioritise your spending if you can, to make sure your money is going as far as possible. 

While your money is losing value, it could be worth seeing if you can put off non-essential purchases. 

While it may be tempting to stop paying into your pension pot in the short term you could miss out on employer contributions and miss out on tax-efficient savings

However, if you’ve been thinking about making a big purchase, such as a car or a required home improvement and you have the money to do so, it may be better to do it now. 

If you wait you risk prices climbing even higher and the pound in your pocket worth less.

Fourth, try to clear any outstanding debt. As interest rates rise – the Bank of England increased the base rate to 1.25 per cent last week – repayments on variable rate debt go up as a result. 

So, if possible reviewing your debt arrangements to save on interest payments could make a real difference.

Fifth, make the most of tax efficient savings. You might find there are different benefits you could get depending on how you save your money, which could make the most of what you’ve got. 

Tax benefits on pension payments mean it costs less to save more into a pension plan. 

So even if you’re focused on short-term finances, it’s important to continue contributing to your pension. 

Stopping paying in to your pot, you may miss out on valuable contributions from your employer. Although remember that you can’t access any of your pension savings until you’re aged 55 (rising to 57 in 2028).

Finally, consider making investments. 

If you want to give your savings the opportunity to grow in line with the rate of inflation, or even beat it, then one of the best ways to do this is to invest over the medium to long term, which is generally five years or more. 

Your pension plan, stocks and shares Isa and any other investments will offer investment options that have the potential to grow your money over the medium to long term – although, in recent months, there has been plenty of market turmoil. 

This post first appeared on Dailymail.co.uk