Savers are losing out heavily as the European Central Bank (ECB) brings interest rates down in an attempt to stimulate the euro-zone economy. With the ECB rate now at 3.25 per cent - and some economists predicting a rate as low as 2.5 per cent by spring - retired people with incomes dependent on the interest from lump sum savings are particularly vulnerable.
In addition to falling interest rates, income from savings is liable to tax at a rate of 20 per cent, reducing the net return. If the net return is less than the rate of inflation, the real return will be negative and the value of the lump sum invested will be eroded over time. For example, even if a saver was getting the current ECB rate of 3.25 per cent, their return after tax would be reduced to 2.6 per cent after tax, well below the current inflation level of 4.3 per cent.
But many savers are not even getting close to the current ECB interest rate on their funds. Some €21.5 billion (£16.9 billion) of the €86.5 billion Irish residents have deposited with financial institutions are in demand deposits - paying in most cases only nominal interest rates (see table). While this amount includes corporate deposits, it indicates a large number of retail customers are getting very low returns on their savings - and that some financial institutions are paying very little for some of their funds.
With saving levels apparently starting to increase as people become more cautious in an uncertain economic environment, savers need to be pro-active with funds if they want to get the best returns. This will be even more important in the future in what is expected to be a low interest rate euro-zone environment.
ECB rates have been cut four times this year. At the start of the year, the ECB rate was 4.75 per cent. In May, it was cut by a quarter point to 4.5 per cent. This was followed on August 30th by another quarter-point cut to 4.25 per cent. On September 17th, there was a half point cut to 3.75 per cent, followed this week by another half point cut to 3.25 per cent.
Financial institutions have followed these ECB rate cuts with selective reductions in the rates they pay savers. The table shows a random sample of the interest rates available on a £5,000 (€6,350) lump sum, though most of the rates have not yet been changed to reflect the latest ECB cut. Savers should be aware that these rates are variable - they change as ECB or interbank rates change - and that the rates on offer from any institution at any time reflect its marketing strategy at that time - and could come down sharply as that strategy changes.
The lowest rates are generally paid on demand accounts, where savers have instant access to their funds. Savers can earn better returns by agreeing to leave their funds untouched for specific periods. Most institutions offer relatively attractive new savings products targeting particular market segments from time to time.
In a low interest environment, savers need to assess the amount of cash they need instant access to and to consider a range of alternative homes for the balance of their savings according to their particular circumstances. Keeping large sums for long periods in low-rate demand deposit accounts amounts to very poor financial planning.
