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Be savvy with savings

    It is over three years since the Bank of England reduced interest rates to just half a per cent and there seems no end in sight to savers' plight.

    Anyone hoping to live on their savings income has been hit by the toxic combination of falling rates and rising inflation. Indeed, Bank of England officials recently warned inflation could continue high for some time yet.

    Savers need to be savvy with their money, shopping around assiduously for the best rates. Instant access accounts pay very little. Tying your money up for a year or more can give much higher returns. However, with inflation still well above the Bank of England's two per cent target, it is virtually impossible to beat inflation on an after-tax basis. So your savings will lose value in real terms each year. Policy seems to be penalising people for their past prudence.

    As if to add insult to injury, savers' much-reduced savings income is also taxed. Receiving savings income tax-free would be the equivalent of a one, two or three percentage point rise in interest rates (depending on your tax rates and current interest levels).

    The easiest way to escape paying tax on your savings income is to put money into an Individual Savings Account (ISA). However, savers can only put half the £11,280 annual allowance into cash. The rest must be held in riskier investments in a "stocks and shares ISA". An ISA invested entirely in overseas shares can take in £11,280 a year, while someone saving in a cash ISA in a UK bank could only shelter £5640 from tax. I find these rules bizarre - it is hard to see how they help the economy or savers.

    In particular, those who are retired, or out of work, should not be encouraged to put their savings into risky investments. Relaxing these ISA restrictions (and even increasing the ISA allowances) would allow all savers to choose how to invest their own money and still receive more tax-free.

    Several years of ultra-low interest rates will undermine long-term savings incentives, which is dangerous in an aging population. A policy of continually bailing out borrowers at the expense of savers is a recipe for economic decline because money is being taken away from savers who could be safely encouraged to spend, and given to borrowers who should really reduce spending and repay their debts. It is important that policymakers acknowledge the damage done to savers and find ways to mitigate the effects.

    Ros Altmann is the director general of Saga and a former government pensions adviser

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