Does it make sense to save when interest rates are so low? As well as that, inflation and the taxman can quickly gobble up your nest egg if you don’t educate yourself on the best ways to save – Conor Pope
What’s the landscape like for Ireland’s savers?
Not great. Interest rates have never been lower, and anyone with a few bob to put aside is paying the price. Rates on deposit accounts can be as low as 0.01 per cent, and few savings accounts of any kind offer rates of more than 4 per cent. To put those numbers in context, if you had €10,000 on deposit and earned a rate of 0.01 per cent, the level of interest after a year would be €1. And you would have to pay Dirt on that, which would leave you with 59 cent.
So have we stopped saving?
Absolutely not. According to figures from the Central Bank of Ireland, deposits held by Irish households went up by more than 1 per cent last year, to €92.2 billion. Right now almost 25 per cent of Irish wealth is held in cash deposits. That is three times more than in frugal Canada and twice as much as our neighbours in the UK.
Should we be saving so much?
While putting aside money for a rainy day might be sensible, too many people putting aside too much is not good for an economy, which needs people to spend and to have the confidence to spend. Many people are putting money aside for an eventuality that has already come to pass, in a phenomenon known as “penultimate preparedness”. People are not saving for the future but to prepare for the financial crisis, which has already come to pass.
Are there any other issues with savings?
Yes. We appear to have a fairly low level of understanding of interest rates. More than a third of those who took part in a recent Irish Life survey guessed incorrectly when asked what the typical rate of return is. Most people overestimate what they will get back.
Is that all the bad news?
No. Then there is tax. Some savers have to give 45 per cent of the interest they make back to the Government in the form of Dirt (41 per cent) and PRSI charges (4 per cent). The 4 per cent charge is applied to people earning more than €3,174 in interest.
Inflation is on the saver’s side, right?
Right now it is. Inflation is often described as a “silent thief” because it reduces the power of capital dramatically. While a rate of inflation of 1 per cent might not sound terrible, it can quickly eat into your savings.
Let’s say you have €50,000 deposit. If you take the interest out each year, then a rate of inflation of just 2 per cent will see the value of your capital fall to €45,200 in real terms in just five years. In 10 years you’ll be worse off by almost €10,000.
Do all the banks offer much the same rates?
No. When it comes to saving it is worth shopping around. The website bonkers.ie allows you to see at a glance what rates are being offered. If you are looking for a regular saver account with instant access, the rates differ wildly. KBC has a deposit account with an interest rate of 4.5 per cent rate for those who also hold a current account with the bank. If you don’t have a current account with that bank, you can get 3.5 per cent. The minimum you can save a month is €100 and the maximum is €1,000. Nationwide UK offers a rate of 4 per cent. All three of those accounts offer instant access.
After that, the rates for regular savers fall dramatically. AIB has an online saver account that gives 2.25 per cent. PTSB’s regular saver account offers 2.1 per cent. Ulster Bank has an account offering 2 per cent. RaboDirect has an account offering a 1.7 per cent. Bank of Ireland offers a fairly miserable 1.25 per cent, and that looks generous compared with its demand deposit account, which offers 0.01 per cent.
What about my longer-term options?
The greatest returns tend to be found when you put a lump sum away for a fixed term. Always look for the annual equivalent rate (AER). Most providers will also give a gross rate for the term, which can make it harder to compare like with like. Which is better: 3.39 per cent over 18 months or 3.53 per cent over 24 months? The former. It has an AER of 2.25 per cent. The latter has an AER of 1.75 per cent.
Who has the best long-term rates?
KBC has a 15-month instant interest online account. It offers an AER of 1.7 per cent. The money has to be on deposit for at least 15 months. RaboDirect has a notice saver 90 account, which delivers the same AER on amounts from €0 up to €1 million. A rate of zero applies on amounts above €1 million, and there is no fixed term once you give 90 days’ notice. All the major banks then offer returns of between 1.25 and 1.6 per cent, with varying terms and conditions.
So what kind of money would you earn if you put €10,000 on deposit for four years?
Bank of Ireland’s four-year growth account offers 1.15 per cent AER (its gross term is 4.58 per cent); the interest after four years would be €458. EBS has a SureCertificate account with a fixed term of 48 months that offers 1.27 per cent AER; the interest after four years would be €520. KBC has a 48-month deposit offering 1.2 per cent AER, which will earn you €488 after four years.
And if you want instant access to the same €10,000? AIB has a demand deposit account offering 0.05 per cent, which would earn you €5 in interest. Bank of Ireland has a six-month Bonus Plus deposit account at a rate of 0.55 per cent, which would earn €55. It also has a nine-month Bonus Plus deposit account at a rate of 0.7 per cent. EBS has a High Yield Access account that offers 0.75 per cent.
Do I always have to pay Dirt?
No. Dirt is now at 41 per cent, which makes State savings more attractive because you don’t have to pay tax on the interest earned. The rates may seem lower than the banking alternatives, but if you factor in the tax saved, the picture changes.
A three-year savings bond pays a rate of 2.5 per cent (AER 0.83 per cent) over the term on amounts of between €50 and €120,000. Once you’re an Irish resident, the interest is tax-free, so if you save €100,000, at the end of three years you’ll have accumulated €2,500.
If you put the same money into a bank account paying an AER of 1.5 per cent, you earn about €4,000 – but tax at 41 per cent will take away about €1,600 from this, leaving you with about €2,400. You will lose another 4 per cent in PRSI charges, which will reduce your earnings to €2,250.
THOSE EXPENSIVE LIFE EVENTS: HOW TO SAVE FOR . . .
. . . College
It costs about €10,000 a year to send a child to college, and most people go for four years. So if you would like your offspring to be educated to third level, the bill will come to €40,000. And that is in today’s money. In 10 years, thanks to inflation and any additional charges future governments might impose, the cost will go up. It could be €60,000 in 2025.
The most sensible way to save for that is to put child benefit into a long-term savings account from the start. Do that and you will have about €28,000 over 18 years. But many people can’t afford that, or at least not when their child is young.
So the second-best option is to put aside a lump sum and then save. If you had a lump sum of €10,000 today and found a deposit account paying 3 per cent a year, you would need to save €289 a month over the next 10 years to meet a target of €54,000. If you find an investment product making an annual return of 5 per cent, you would need to put aside €240 a month on top of the €10,000 lump sum.
Investment products are generally better options, but they are not without risk. Standard Life’s Global Absolute Return Strategies fund aims to deliver an investment return regardless of volatile stock market movements. It is nearly 10 years old; the annual return in that time has been 8.2 per cent. But as the small print says, past performance is no guarantee of future returns. There’s no capital guarantee on this fund and the value of the investment and any income you earn could go down as well as up.
Irish Life’s Pinnacle savings plan puts your money into various investment funds. You must save at least €250 a month for at least five years, and you can also invest lump sums of up to €25,000 into the fund. You can withdraw your money within the first five years, but there’s a charge if you do. There is no charge on withdrawals after that point. There’s also an annual management fee, which depends on the exact nature of the fund, but 1.25 per cent per year would not be too wide of the mark.
If you prefer ordinary savings accounts, Ulster Bank’s special interest deposit account pays 2 per cent AER on balances between €1 and €15,000 and 0.75 per cent gross/AER (variable) on balances above that €15,000. EBS’s family savings account pays 2.25 per cent.
The State offers Instalment Savings based on 12 monthly savings, which are left on deposit for a further five years. It offers 7 per cent return on your savings after that period, which works out at 1.24 per cent. The minimum savings are €25 per month and the maximum €1,000 per month.
. . . Wedding
Work out the cost of your wedding and set a budget. The sooner you start saving the less painful it will be. Consumerconnect.ie has a budget calculator that will allow you easily work out how much you will need for more than 20 things that make up the typical Irish wedding.
Then carry out a financial review to highlight spending areas you might need to cut back on. If a couple has outstanding debts such as loans or credit card bills, concentrate on clearing them first, starting with the most expensive ones.
Use a savings calculator to help you work out how much you will need to save to meet this target or how long it will take if you have a monthly sum in mind. That can be quite depressing. If a couple wants a wedding that costs €22,000, and they save €400 a month into an account with an AER of 3 per cent, it will take them the guts of four years to save for a wedding. The sooner you start to save, the more manageable the cost will be.
Decide where to stash your savings. You could open a straightforward instant-access savings account, but if you have a couple of years to go, you may want to look at accounts that tie up your money but offer better interest.
Even with your savings, you still might need to borrow some money. Bonkers.ie and consumerconnect.ie all have loan calculators to see how much it will cost and how long it might take to repay a loan, depending on the amount you want to borrow. If you do borrow, make the most of cash wedding gifts.
. . . Retirement
All things being equal, someone without a private pension can rely on the State when retirement comes. The State pension is now €230.30 per week. But if you would like to spend your golden years taking round-the-world trips and doing other fun things, you will need more than that.
Although it is nearly 20 years old, the National Pension Policy Initiative of 1998 is still a good guide to how much you might need. It suggested an “adequate” gross retirement income of 50 per cent of gross pre-retirement income.
So if you earn €80,000 on the day you retire, you need a pension income of €40,000. If €12,000 a year of that comes from the State, you need €28,000. To reach that magic number, you will need a fund of €700,000-€930,000.
If you want to have a retirement income (including the State pension) of €30,000, you will need an annual private pension of €18,000. For that you will need a fund of €350,000.
Someone who starts a pension at 25 will need to save €238 every month. A person who starts 10 years later will have to find €432, while someone who puts off their pension until 45 will need to put €864 into their pot every month for 20 years to get to that number (which is based on 6 per cent growth per year).
Pension tax relief is 40 per cent and is probably the best tax break available to the “squeezed middle” right now. Why would you give the taxman 40 per cent of your pay packet if you could save it into your pension nest egg instead?
Pensions have peaks and troughs but, looking at the big picture, they are still the better option for securing your future. The average managed fund over the past 30 years has returned about 9 per cent per year. The best post-office tax-free returns offer 5 per cent per year.
When it comes to a private pension, always go for providers who have a good record and are financially strong. Some providers, especially insurance companies, have been offering pensions for many years and are backed by huge financial resources. FTSE 100 companies include Aviva, Standard Life and Zurich. Irish Life is an option closer to home.
Pension products offering wider investment options are more accessible than ever. You can put in as little as €25 per month to start building a portfolio. Not everyone is comfortable choosing risk-appropriate investments for themselves. Other people can do the tweaking of your portfolio for you. One such example is Standard Life’s Myfolio, which gives ordinary investors access to actively managed funds.