How to protect your UK savings from inflation

The rising cost of living may have forced you to rein in your spending over recent months, but have you considered the impact of inflation on your savings?

In this article, we look at how inflation works, what it means for you and how high-interest savings accounts and other investment vehicles can help to mitigate the impact of rising prices.

Inflation is a measure of the rate at which the price of goods and services increases over a set period. So, if a £1 tin of soup rises by 3p, the rate of soup inflation is 3%. Rising inflation results in a reduction in the purchasing power of money. In other words, you’ll get fewer goods and services for your pounds and pence. 

You only have to look back over the last few decades to see the effects of inflation. For example, in 1970 £1 was able to buy 10 loaves of bread. Fast-forward to 1980 and this had fallen to three loaves. By 2020, £1 could buy you just one loaf of bread. This is the result of inflation and the fall in purchasing power over time.

What is the current rate of inflation?

The Bank of England (BofE) aims to keep inflation at 2%. However, the Covid-19 pandemic and the global surge in energy prices pushed UK inflation to record highs. Inflation was close to zero in February 2021, but by July 2023 it had increased to 7.9%. In an attempt to tackle the problem, the BofE repeatedly raised the UK base rate, and while this led to increased interest rates on many savings accounts, it also made borrowing more expensive. If, as expected, there is a sharp slowdown in inflation in 2024, the BofE will be able to start cutting interest rates, so now is a great time to lock your money away. The most up to date inflation figures can be found on the Bank of England website.

As a conscientious saver, understanding these dynamics is key to safeguarding your finances.

With the cost of living crisis ongoing, it is important to protect your savings from the effects of rising prices. But how do you guard savings against inflation? While we can’t promise you’ll be able to ‘beat inflation’ with savings, anything you can do to mitigate its impact and increase your buying power is always worthwhile.

If you’re wondering what to do with your savings during times of high inflation, here are some strategies that may help. The best approach for you will of course depend on your financial situation, savings goals and appetite for risk, so do seek expert advice if you’re unsure.

Here are five ways you can protect your UK savings from inflation: 

1. Shop around for the best interest rate

You should always shop around to find the best interest rate, but in times of high inflation it’s more important than ever. When comparing savings providers, it’s worth searching beyond the familiar high street banks; you’ll often get a better deal if you look at alternative providers. There are plenty of comparison tools available online, or simply use the table at the top of this page to compare competitive savings accounts from our partner banks and building societies.

2. Consider longer-term savings accounts

If you really want to maximise your savings interest and mitigate the impact of high inflation, it might be worth considering a long-term savings account such as a fixed rate bond. These types of accounts require you to lock away your money for a set term – typically one year, two years, three years, five years or six months. 

In return, you’ll receive a guaranteed, fixed rate of interest that’s usually higher than that on instant access and easy access savings accounts. Generally speaking, the longer you can afford to lock your money away, the higher the interest rate will be.

While fixed rate bonds can be a good option for anyone exploring how to beat inflation with their savings, it’s important to note that they won’t suit everyone. Once you make your initial deposit, you can’t access your cash until the account matures (at least not without incurring a penalty). So if there’s a chance you’ll need to access your savings before the end of the term, or if you want to use the money to cover emergency expenses, this probably isn’t the right type of account for you.

If you’re looking for a more flexible savings option, you may want to consider a notice account or an easy access savings account. While the interest rate will usually be lower, there are still plenty of competitive deals out there if you’re prepared to do your research.

3. Consider equity investments

If you’re exploring how to profit from inflation or looking to diversify your savings portfolio, equity investments may be a good choice. With equity investments, you’re investing money into a company by purchasing its shares, which are small pieces of the company. Shares are also referred to as stocks. If you own stocks, you’re entitled to a portion of the profits and assets the company makes. 

Stocks typically beat inflation in the long-term, because companies can increase their share price to keep up with increasing costs brought about by inflation. For example, if wages and production costs rise because of inflation, a company might pass these costs to their consumers by raising their share prices, and the cost of their goods or services. 

While equities have historically proved to be one of the most effective inflation-beating investments, there is a high degree of risk involved. The unpredictability of the stock market means you could stand to lose all, or part of, the value of your investment.

If you’re not comfortable with the level of risk that comes with investing for inflation, you might want to consider opting for a high-interest savings account such as a fixed rate bond instead.

4. Research other inflation-beating investments

Equity investments aren’t the only vehicles that can protect savings from UK inflation. Index-linked bonds, also known as gilts, have also proved profitable for many investors. Offered by the government, they make coupon payments based on the retail price index (RPI), which measures inflation. A higher inflation rate results in a higher coupon payment. 

Given the current economic climate, demand for index-linked bonds is extremely high, and they are trading at premium rates. To determine whether this is the best option for you, we recommend speaking to a financial adviser. They can help you decide what to invest in during high inflation and compare a range of investment vehicles to create a solid inflation-beating portfolio.

5. Take advantage of tax breaks

Maximising tax-efficiency is crucial if you want to make the most of your savings and investments. Whatever investment route you choose, it makes sense to use any tax breaks while they’re available. 

Thanks to thepersonal savings allowance (PSA), many people don’t pay tax on their savings interest. However, with interest rates on savings accounts rising, more of us are at risk of exceeding our PSA and therefore incurring a tax charge. If this applies to you, it might be worth thinking about utilising tax-free saving accounts such as ISAs. You can save up to £20,000 in an ISA every tax year without having to pay tax on any interest earned. 

There are currently four types of ISA available:

• Cash ISAs

• Stocks and shares ISA

• Innovative finance ISA

• Lifetime ISA

You can open more than one type of account, but the maximum investment allowance applies to you as an individual, not to each account you open. 

Investing in a pension scheme is also a great way to minimise tax, as the government effectively tops up your contributions in the form of tax relief. The amount of tax relief you receive will depend on your taxable income – in some cases it’s worth up to 45%. 

The maximum amount you can pay into your pension pot and receive tax relief for (the annual allowance) is £60,000 in 2024/25 (up from £40,000 in 22/23). Meanwhile, the lifetime allowance is currently set at £1,073,100, although this is due to be abolished completely from 2024/25.