Tax Efficient Investing Can Help Offset the Impact of Rising Inflation

COVID-19 has created a particularly tough environment for savers. Interest rates have been held at historic lows of 0.1% for more than a year now. With many people being furloughed or made redundant, household finances have taken a knock with many cash savers forced to put their long-term savings goals on hold because of the coronavirus pandemic.

Adding to the financial anxieties of many Britons, however, is the fact that inflation is steadily on the rise. Just this week (21st April 2021), it was announced that inflation rose to 1.5% % throughout April as lockdown rules ease and adults can spend their money on the high street, as well as online.

The steady increase in inflation could be viewed positively. The fact that fuel and clothing costs are returning to pre-pandemic levels signifies that the UK is turning a corner in its post-COVID recovery. Likewise, low base rates have made borrowing cheaper, which have helped to facilitate greater consumer spending and wider economic growth. However, savers may experience more damaging effects.

The combination of low interest rates and increased inflation have the potential to hit savers hard.

So, this increased cost of living, teamed with consistent rock-bottom interest rates could mean that people’s cash saving will lose value in real terms.

This may seem like an unnerving prospect. However, there are tax efficient investment options that offer better returns and thus lessen the negative impact of rising inflation.

Exploring alternatives

Whilst in the current climate, traditional savings accounts might not seem overtly appealing, there are other options depending on your attitude to risk.

One possible option you may wish to consider is the Innovative Finance ISA (IFISA) which was first introduced at the beginning of the 2016 tax year.

An innovative finance ISA lets you use your tax-free ISA allowance while investing in peer to peer (P2P) lending.

P2P lending is a type of investing where you directly lend money to borrowers and businesses. The borrowers then pay back the borrowed amount, plus interest, which you earn free of tax.

Investors (IFISA holders) are matched up with borrowers. A borrower could be a business, an individual or a property development company.

Before deciding whether this is right for you, it’s worth taking some professional advice to see if an IFISA is right for your circumstances.

When it comes to choosing an innovative finance ISA, here are 5 questions you should ask before investing.

1. Who will you be lending to?
2. how long you’ll have to tie your money up for?
3. what return will you receive?
4. What is the provider’s track record?
5. Are there any management costs?

You can only open and pay into one IFISA in each tax year. But you can also pay into a cash ISA and a stocks and shares ISA, too. You just need to make sure you don’t exceed your ISA allowance across all your ISAs.

An IFISA not without risk and not right for everyone, but it can pay higher returns than cash in a bank savings account and help reduce the impact of rising inflation which can otherwise erode the spending power of your nest egg.