Cash is the most straightforward and trusted of the asset classes. Most people would agree that decisions concerning investment in shares or bonds demand careful thought, but might feel that there’s a lot less to think about when it comes to cash.
This may be so, but this doesn’t mean that the decisions you make won’t have serious consequences when you’re planning your future. Firstly, you need to consider where to keep your cash. This boils down to a choice of three main options:
1 Inside a pension
Many people don’t appreciate that they can keep cash in their pension. Keeping your cash savings inside your pension is good because the interest is paid tax-free and pensions are also excluded from your estate for inheritance tax purposes. The downsides of keeping cash in your pension are that interest rates are usually lower and you’ll pay pension administration fees. There’s also the issue of accessibility – you won’t normally be able to take cash from a pension until you reach 55.
2 Inside an ISA
Cash ISAs have proved popular over the years, but the new Personal Savings Allowance means that you can now receive tax-free interest on cash savings in an ordinary deposit account. The February edition of Thinking Ahead [link to http://www.aviva.co.uk/retirement/news-views/report/big-changes-to-the-way-bank-account-interest-is-taxed/] discusses the options in detail.
3 In an ordinary cash deposit account
Ordinary cash deposits can now receive annual interest of up to £1,000 for a basic rate taxpayer and £500 for a higher rate taxpayer without deduction of tax. And, of course, it has always been possible for non-taxpayers to receive interest payments gross. This means that ordinary cash deposits can be just as tax-efficient as ISAs, so don’t dismiss them.
And, of course, it has always been possible for non-taxpayers to receive interest payments gross. This means that ordinary cash deposits can be just as tax-efficient as ISAs, so don’t dismiss them. For further information see the February issue of Thinking Ahead [link to http://www.aviva.co.uk/retirement/news-views/report/big-changes-to-the-way-bank-account-interest-is-taxed/
Risks? But it’s cash, isn’t it?
When we think of cash, we think of safety or that cash is risk-free. However, wherever you keep your cash, there are a couple of risks in holding savings as cash that you should consider:
1. The bank or building society holding your savings goes bust
The Financial Services Compensation Scheme, run by the government, pays compensation for financial loss. Compensation limits are ‘per person per firm’ and, in the case of cash deposits, the maximum level of compensation is currently 100% of your deposit up to a maximum of £75,000. If your cash savings, or the combined total of yours and your partner’s, are more than £75,000 it would be sensible to split cash savings between the two of you. Alternatively, you could spread your savings between different banks or building societies. If you’re thinking about doing this, make sure your new choices aren’t in the same group of companies, as the ‘per firm’ rule applies at the highest level. For example, Royal Bank of Scotland and NatWest Bank are part of the same group of companies – so only one compensation limit applies, even if you have savings accounts with both.
Inflation is a creeping risk to cash savings that often goes unseen. The Bank of England Base Rate has been at 1.5% or lower since 8 January 2009. Since then, the consumer price index measure of inflation has ranged from -0.1% to 5.2%, with an annual average of 2.3%.
If your savings have been earning a lower rate of interest, then you are losing purchasing power. This is because the spending power of your cash savings is falling. The only way to counter the risk of inflation eating into cash savings is to constantly scan the market for cash deposits, looking for the best rate of interest. You may also need to lock your money away in a fixed term deposit to earn the best interest rates. However, even if you continue to chase the best rate of interest on your cash deposits, there is no guarantee that the rate of interest earned will match or beat the rate of inflation.
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