17 June 2022

The UK inflation rate’s currently rising at its fastest rate for over 30 years. It’s just hit 9% and the Bank of England’s warning that it might reach 10% by the end of the year.

You’ve probably already seen the impact of that in your daily life – the price of just about everything has gone up. But inflation doesn’t just affect the money you spend. It can shrink the value of your savings, too. In this article we explain how that works, and share some tips on how to deal with it.

What exactly is inflation?

The inflation rate tells you how much prices increase over a time.

It’s usually given as a percentage, describing how much prices rise every year. So if there’s a 10% inflation rate, a product that costs £1 right now will cost £1.10 in a year’s time. The product won’t have changed in any way, but its price will have increased by 10p, in line with that 10% inflation rate.

If you look back at how your grocery or energy bills have gone up recently, you’ll see inflation in action. You’re probably already thinking about how to deal with any more cost of living increases. But are you thinking about how inflation might affect your savings?

That can be a lot harder to spot, but it’s very important to keep an eye on how inflation and savings interact. As Emma Byron, Managing Director of Legal & General Retirement Solutions, says:

“Inflation is at its highest rate for three decades, and it’s worrying that 52% of savers don’t realise it’s eating away at millions of pounds sitting in low-interest-paying accounts.

“Understanding the effects of inflation is crucial to knowing how much money you have in real terms. While it is essential to keep some cash in the bank for an emergency fund, savers might want to consider other options to make their money work harder, and protect their savings from inflation.”

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So how does inflation affect my savings?

One way to understand the inflation vs savings battle, is to imagine stuffing £100 under your mattress for a few years. What will happen to this money? On the face of it, not a lot. No matter how long you leave it there, there will always be £100 tucked under your mattress.

But when you come to spend your £100, inflation means you won’t be able to buy as much with it as you could when you first put it there. Its buying power will go down, as inflation pushes prices up. You might need £110 to buy something that cost £100 when you first stashed your money away.

Looking at it another way, imagine that you lift up your mattress tomorrow and there’s only £90 there! You’ve lost £10 in the time that it’s been tucked up.

Does this feel like a good return for your hard-earned money? Not at all. And that’s the impact of inflation on savings.

The same thing can happen to cash savings that have interest rates below the rate of inflation. If the interest rate you get on your savings is less than the inflation rate, then you’re losing money.

Currently, savers have £136 billion sitting in cash ISA accounts. And with an average interest rate of 0.26% per year for instant access cash ISAs, inflation is having a big impact on savings:

  • If inflation increased by at least 6%, for every £1,000 stashed away, savers would lose on average £243 over five years – and it would only take 13 years for savings to effectively halve.
  • If inflation increased by at least 8%, for every £1,000 stashed away, savers would lose on average £311 over five years – and it would take less than 10 years for savings to effectively halve.

That’s why it’s so important to know how to protect savings from inflation. UK savers aren’t always aware of it, because inflation has been so low for the last three decades. Between 1989 and 2022, it averaged out at 2.55%. And as Emma pointed out, 52% of savers don’t even realise that inflation’s a problem.

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How do I protect my savings from inflation?

Our three tips can:

  • Make your money work harder for you
  • Help its buying power stay strong.

Tip 1: Work out how much to put aside as an easy-access emergency fund

The Money Helper service suggests that you should save for emergencies. As a rule of thumb, you’ll need enough to pay your essential expenses for three months. You should be able to cover costs like energy, mortgage or rent, travel and food costs.

That way, should the unexpected happen, you’ll be ready. And you’ll know exactly how much money you need to keep in cash (which can be hit by inflation), so you can start saving any extra income in more inflation-proof ways.

Tip 2: Find the best interest rate you can on your savings  

Make sure that any cash savings you have, are getting the highest interest rate possible. These days you can switch savings accounts and ISAs relatively easily. But if you decide on an ISA and want the best rates, you might need to commit to a particular product for a year or more. As a rule, the longer you’re willing to commit, the better rate you’ll get.

If you do go for a long-term ISA, set a reminder for when it ends, so (if you want to put your savings into another ISA) you can look around and find the best new deal. You can find more information on most bank websites, and compare interest rates on comparison websites.

Tip 3: Think about long-term investments

If you have some money you don’t need to touch for at least five years, and are wondering how to beat inflation during that time, think about putting it into a stocks and shares ISA. They’re seen as mid-to-long term investments, so you should only invest your money if you can afford to wait out any fall in its value.

And of course, past performance isn’t a reliable indicator of future performance, and the value of your investment will go up and down. It isn’t guaranteed, so you may get back less than you put in.

You don’t have to be a financial expert to invest. Many stocks and shares ISA providers have a range of investments, that can match how much risk you want to take with your money. You just choose what works best for you. Our ISAS Explained and Investing for Beginners pages will tell you a bit more about how to do that.

Our Stocks and Shares ISA

Learn all about our Stocks and Shares ISA and it's key benefits.

What inflation rate is used for pensions?

There’s no single inflation rate for all pensions. In the past, the State Pension increased annually in line with the triple lock. That meant it would grow by 2.5%, the rate of inflation (as measured by the consumer price index) or average earnings / wage growth, following whichever figure was the highest. But wages shot up in 2021 as people came off furlough. So in September 2021, the government replaced the triple lock with a double lock in line with the rate of inflation at the time. And in 2022, the State Pension went up by just over 3%.

Your personal or workplace pension pot will grow (or possibly shrink) in line with how much money you put into or take out of it, any investment choices you make and the performance of the markets. There’s no fixed rate for that. But on average, pension funds grew by 7.3% from 2015 to 2021. The average inflation figure for the same period was 1.5%, so pension funds outperformed inflation during those years. In May 2022 UK inflation hit 9%, outstripping both historic pension fund and current State Pension growth.

That helps us answer the question: “Do pensions rise with inflation?” Historically, yes they did. But they might not keep up with it in future. That makes it even more important to keep an eye on your pension pot. Check it regularly to make sure it’s growing in line with your expectations. You might need to change how it’s invested or up your contributions. If you’re not sure how much to save, our Retirement Income Calculator can help. It will help you explore how much income you can get with different pension pot amounts and retirement ages.

What's next?

It might be time to check how your savings are doing against inflation. If you find that they aren’t keeping up, and maybe even losing value, think about following our three tips above. And if you decide you’d like to invest in a stocks and shares ISA, you can visit:

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