The Bank of England has finally begun lowering its base rate, more than two years since it began hiking in order to quell soaring post-pandemic inflation.
Rising rates over the course of 2022 and 2023 have meant that savers have had access to higher savings rates for the first time in over a decade.
However, rates have seemingly ‘peaked’, meaning we may soon see savings rates begin to fall. This puts a renewed emphasis for anyone with long-term financial plans in mind to ensure their money is working as hard as possible and is structured to be as tax efficient and secure as it can be.
We know that the thought of falling rates is something that will be a concern to many and want to provide some reassurance and highlight important considerations to help you protect your financial plans.
1. FSCS coverage
Savings deposited with licenced banking businesses are protected by the Financial Services Compensation Scheme (FSCS) up to the value of £85,000 per account.
It is advisable, therefore, to ensure that no one savings or other kind of bank account has more than this amount in it. Although unlikely, as we saw in the US in 2023, bank failures do happen. Some accounts, which have e-money licences rather than banking licences, also don’t carry FSCS protection at all.
Spreading cash between different accounts in order to mitigate the FSCS limit is advisable. It is less well-known, but investments also have FSCS protection at the same level. While your investment itself isn’t protected from failure, the provider which houses your account, such as pensions or ISAs, typically are.
2. Structure
Cash can be a ‘safe haven’ in the right circumstances. When rates were rising and investment markets were struggling, cash was a tempting choice.
But with rates now waning, it is important to reassess whether your savings are in the right vehicle, or the right structure. This can have important tax implications.
These implications come down to where you spread your long-term savings. Maximising ISA and pensions allowances is essential if possible. Which one you prioritise also matters as certain reliefs and allowances will be available depending on your stage of life. The key here is to consider seeking financial advice to ensure this structure is as efficient as possible.
The structure of your long-term savings also matters for other taxable life events including preparing for inheritance tax (IHT) and Capital Gains Tax (CGT) liabilities.
3. Headline vs bonus rates
Headline savings rates can be misleading when they present what is in effect an initial ‘bonus’ rate. These rates typically end after 12 months, reverting your savings to a much lower savings rate at the end of the deal.
With the rate environment where it is now – having risen significantly but on the edge of falling, these bonus rates will be expiring in many cases for people who took one- or two-year savings rates.
Bonus rates mask the reality of savings rates, that average rate – i.e. the rates most people get on their cash – are much lower. Average savings rates for an easy-access cash ISA are just 2.78% according to price comparison site Finder.
These rates are likely to plunge in the near future as base rate reductions take full effect, meaning your cash may no longer keep pace with inflation.
The long-term role for cash
Cash has a role to play for our financial plans. But with rates set to fall, now more than ever that role is primarily as a short-term safety net in the form of the tried and tested ‘rainy-day fund’.
Over 10 years the average instant access savings rate has been 0.64% according to Finder’s data. This compares against the MSCI World Index – a broad measure of the global stock market – which has a 10-year annualised return on just under 10%.
While savings rates are unlikely to hit such lows again, they are going to fall and likely won’t recover once central banks discover the neutral rate of interest.
Instead, a rainy-day fund should form a starting point of a wider long-term portfolio that incorporates all the tools available to us to ensure the best long-term financial outcomes possible. In order to achieve this, speaking to a financial planner is the best way to ensure that journey is as successful as possible.