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By Cliff D'Arcy
This article was first sent to Fools as part of our 'Summer Lolly' email campaign. What have you been up to this summer? Unless you've been living in a cave and surviving on a diet of berries, then you probably know how steeply the cost of living is rising. Indeed, the cost of energy, food and fuel seem to be going through the roof at present. Over time, price rises produce higher inflation, which is why, last month, one measure of inflation - known as the Retail Price Index (RPI) - leapt from 3.8% to 4.2%. Together, inflation and tax harm savers Inflation is a nightmare for savers, because it erodes the value of their cash deposits. For example, with inflation at 4% a year, the value of money halves every seventeen years. In this case, £1 would buy goods worth just 25p (in today's terms) after 34 years. Thus, it's essential for savers to ensure that their savings interest rate is high enough to beat inflation. Otherwise, they will see a decline in the real' (inflation-adjusted) value of their nest egg, emergency fund or rainy-day money. Even worse, the taxman is lurking in the wings, ready to grab a slice of savings interest earned by taxpayers. Basic-rate taxpayers lose a fifth (20%) of their savings interest to HM Revenue & Customs. In their case, tax reduces a savings rate of, say, 5% to 4% after tax. For higher-rate taxpayers, the problem is doubled, because they lose two-fifths (40%) of their savings interest to HMRC. This slashes a rate of 5% to a mere 3%. At certain times in recent economic history, inflation has soared so high that no savings account has been able to keep up. For instance, in August 1975, the RPI hit a whopping 26.9% - a rate that no saver could hope to match. However, over the past ten years, the RPI has varied between 0.7% and 4.8%, which is much less of a challenge for savers. Can savers beat inflation today? The answer to this question very much depends on your personal tax rate. The table below shows how much savers would have to earn in order to match the current RPI (4.2%), after accounting for tax:
Finally, one good way to beat inflation over the long term is to invest in businesses via the stock market. One easy way to do this is to invest in an index tracker. Over time, this cheap, simple investment will capture almost all of the returns from the UK stock market. So, if the world economy does well, so too will your investment. Good luck in your battle against inflation! Visit The Fool's Savings Centre to find an inflation-busting savings account! Useful links:
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