‘Hidden tax’ could erode your ‘comfortable retirement’ fund and squeeze savings

Dominic Raab grilled by Nugent over 'worries' about inflation

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Inflation, as measured by the Consumer Prices Index (CPI), hit 3.2 percent in August and the Monetary Policy Committee warned it could rise further as 2022 approaches. Rising inflation will have an impact on many financial assets, from savings to pensions, and new analysis from Brewin Dolphin highlighted just how costly it could be.

How much is inflation costing you?

Lee Clark, a financial planner at Brewin Dolphin, warned: “Inflation isn’t a bill that you pay directly, but it can cost you over the long run. Without careful financial planning, you run the risk of your money’s purchasing power being eroded over time. Taking financial advice could help you avoid this so-called ‘hidden tax’.”

To illustrate how damaging this could be, Brewin Dolphin calculated £100 invested in the stock market (specifically, the FTSE All Share Total Shareholder Returns fund) in 1996 would be worth £322 today, compared with £131 in cash savings.

However, ££100 now would be worth only £54.50 in terms of buying power after 25 years of inflation at 2.5 percent

This would also have an impact on day-to-day spending as inflation broadly refers to the way in which prices for goods and services increase over time. While increases may not be felt initially, the effect is more pronounced over longer periods of time, with the Bank of England’s own inflation calculator showing goods and services costing £10 in 1980 would cost £43.85 today.

It should be noted these types of increases could easily be seen over the coming decades. This is because inflation has averaged 3.8 percent over the last 40 years.

Mr Clark continued: “Higher food and fuel bills are the most noticeable effects of inflation. If your salary hasn’t kept up with inflation, you might find your household finances are squeezed. A less obvious effect of inflation is the way it erodes the value of your savings.

“If you have £100 sitting in a zero-interest bank account then over time, inflation will reduce the ‘real’ value of your £100. After 25 years, you’ll still have £100, but you’ll be able to buy significantly less with it than you could at the start. For example, £100 now would be worth £54.50 in terms of buying power after 25 years if inflation was at 2.5 percent.”

This will be particularly disheartening for savers who struggle to find a savings account which could beat inflation. According to analysis from Moneyfacts, there are now no savings accounts which beat inflation, with the average No Notice Savings Rate sitting at 0.23 percent on October 1.

Long-term savings products such as pensions will also be impacted by inflation, even where rising costs are factored into the planning.

Mr Clark said: “If you’re saving for a long-term goal, like retirement, then it’s really important to factor in inflation. You might think saving up £600,000 will set you up for a comfortable retirement but, in 20 years’ time, it’s very unlikely that £600,000 will go as far as it does now.”

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How to protect yourself from inflation

Unfortunately, there are no easy answers for how inflation can be beaten. Brewin Dolphin explained that in order to prevent inflation from “eroding your savings”, savers will have no option other than to ensure their money grows at or above the inflation rate.

This will be easier said than done as the rate changes from year to year, and even month to month. 10 years ago, the inflation rate reached above five percent, so even if inflation lowers “you can’t assume it will stay that way forever.”

Those looking to savings accounts will struggle to find any which pays enough to cover this. According to analysis from Brewin Dolphin, the highest rate on an easy access savings account is around 0.6 percent, while the highest rate on a five-year fixed- rate savings account is 1.8 percent.

Unfortunately, savers may have to look into riskier options just for the chance to keep up with inflation. While investing in the market never guarantees returns, Brewin Dolphin showed investing in the FTSE All Share in 1996 would give saver’s money “the opportunity to beat inflation.”

Mr Clark concluded by examining how investment journeys should be started carefully.

“If you keep all your money in cash, there is a high chance it will lose value over time, which could put your financial plans in jeopardy,” he said.

“Investing in the stock market can give your money the opportunity to beat inflation and grow in value. Equities carry investment risk, but history demonstrates that, over the long term, they tend to outperform cash and produce an above-inflation return.

“The important thing to remember is that equities go up and down in value.

“This means you should invest for the long-term – at least five years – and spread your money across different asset classes, sectors and regions. By diversifying your money, you can reduce the impact of one asset or sector falling in value.”

Furlough, Universal Credit and energy bills

While long-term inflation poses a risk to savers, more immediate threats could force families to act sooner rather than later. From today, Universal Credit payments will lower by around £20 a week, with many experts warning this will hit claimants at the worst possible time.

Additionally, Government support via the furlough and SEISS schemes have ended and an energy crisis looms as the winter approaches.

Myron Jobson, a Personal Finance Campaigner at interactive investor, commented: “The furlough scheme was a lifeline for millions of UK workers during the pandemic and while many good things have to come to an end eventually, it does so at an uncertain time.

“The rise in the cost of living exacerbates matters, with the Bank of England forecasting inflation to reach four percent before the year is out, while the introduction of a new higher energy cap, which is set to add an additional £139 a year to typical default domestic energy bills, puts further pressure on household finances. The nation’s most vulnerable face an additional salt in the wound as the £20 a week uplift to Universal Credit and Working Tax credits is set to end.

“In a recent poll of f interactive investor website visitors, 84 percent said they have noticed the impact of rising inflation in their day-to-day life, with 55 percent stating that it is one of the biggest threats to their personal finances. The furlough scheme has undoubtedly kept a lid on unemployment, but the burning question is: what happens next?”

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