Looking for a safe place to put a lump sum? You can beat both tax and inflation in a way that is guaranteed by the British Government to be 100% safe.
If you’re lucky enough to be a higher-rate taxpayer, you probably have some savings in the bank – particularly at the moment, when cash is king
But did you know that you could effectively be losing money on your savings?
That’s because you will pay 40% on the interest in any savings account. And with retail price inflation riding high at 4.8%, you need to earn interest of 8% just to match inflation.
Otherwise, the combined effects of tax and rising prices will rapidly erode the true value of your money.
Of course, the best tip for any cash investor, higher-rate taxpayer or not, is still to tuck the maximum allowance of £3,600 into a cash ISA each April.
My fellow Fool Jane Baker recently wrote about an excellent new ISA offer, and the Fool has plenty of other tips on choosing ISAs.
But what if you’ve maxed out your cash ISA allowance? What should you do then?
Tax trap
Remember, just to match inflation and the taxman, you need to be earning 4.8% after tax – or a whopping 8% gross.
The Fool offers a handy way to list all the savings and bonds out there by rate – which reveals that even the Fool’s best new bonds can’t quite get to 8%.
In fact, the only savings accounts paying 8% are regular saver accounts. This is bad news for big savers and those with lump sums who want to be able to access their cash easily. Typically, the maximum you can invest in a regular saver account is £250 a month, and your money is inaccessible most of the year.
Beat inflation
Luckily, there is a solution to this problem – and it’s particularly beneficial for higher-rate taxpayers.
It’s one of my favourite products on the market (drum roll): the National Savings Index-Linked Certificate, recently praised by Jane Baker here at The Fool.
It is guaranteed to beat the rate of inflation (as measured by the Retail Prices Index) by at least 0.85%, as long as you do not make any withdrawals in the first year.
After the first year, the rate increases yearly by a set amount, to a maximum of RPI plus 1.21% on the three-year certificate and RPI plus 1.36% on the five-year certificate.
So if you leave your money in the certificate for the full term, you’ll get the best return overall (inflation plus 1% AER) – but you can withdraw your money after a year and you’ll still receive at least the rate of the RPI plus 0.85%.
Most analysts don’t expect inflation to rise much further, but it is possible, and these certificates will protect your savings from any more rises in the cost of living.
Beat tax
Perhaps most importantly, even though these certificates are not ISAs, the interest you receive is completely tax-free, unlike any other savings account or bond on the market.
So at present the certificates offer an AER of 5.8%. But because the return is tax-free, this is equivalent to 9.67% gross on an ordinary account for a higher-rate taxpayer. They’re also a good deal for basic-rate taxpayers too, equivalent to a 7.25% return. Fantastic for savers who have maxed out their ISA limits this year.
What’s more, the application process is online, and simple. You can invest up to £15,000 per issue, and there are several issues a year.
Stay safe
Finally, National Savings are also backed by the government, and hence as secure as you can get – in other words 100% safe.
By the by, Premium Bonds prizes – also from National Savings – are tax-free as well, like all gambling winnings. Overall, they pay an average of 3.4%, equivalent to 5.67% for higher-rate taxpayers, which does inflation.
But these ‘average’ returns are skewed towards the larger prizes, meaning Premium Bonds are best regarded as a bit of fun rather than a serious way to save.
The friendlier way
There is one other, little-known tax-free way to save. It’s offered by ‘friendly societies’ – mutually owned groups, many with long histories.
However, you can only save up to £25 per month, or £270 per year. And you must hold your money for 10 years for the tax-free exemption to apply.
So, this isn’t really going to solve anyone’s problems.
Nevertheless, if you like the idea of mutual savings, really don’t like the Inland Revenue, and plan to save regularly over the long term, the Association of Friendly Societies can help you find out more.
And finally
Of course, as a higher-rate taxpayer, there are numerous other ways to save money, besides actually saving. Pension investing becomes even more attractive, as do ‘salary sacrifice’ schemes.
The Fool also has a few canny tips on tax-efficient saving. But whatever you do – make sure your hard-earned money isn’t being eaten away by tax and inflation!
More: Save 25% Of Your Net Income
> Compare savings accounts at Fool.co.uk
