The UK just joined us i experiencing a phenomenon known as a “negative real interest rates,” where the rate of their central bank is less than the rate of inflation. The Bank of England’s base rate stands at 4.5% and their recent calculation of inflation puts it at 5.2%, meaning savers are seeing their savings erode at 0.7% a year. The Federal Reserve, the United States’ central bank, current set its target interest rate to 1.5% with inflation, especially if you don’t use the bogus sans food/fuel measure, being much much higher.
The economic climate has made it wrong, financially, to save money!
Individual Savings Accounts
One of the ways UK citizens can combat this is to use what’s known as an individual savings account, a type of account unavailable to us here in the United States. Individual savings accounts can get pretty complicated but the part that I find intriguing is that it incentivizes saving, something we Americans have a difficult time doing.
The ISA has two components, a cash component and a stocks and shares component. Without getting too deep into its inner workings, especially since I have no hands on experience with it, the part that I like and feel we need is the cash component. Each year, eligible persons can contribute up to £3,600 into the cash component and the interest earned is tax free. (The stocks and shares portion has a higher limit but all the income derived from that component are also tax free). I admit that I might not know all the details about ISAs, but at first glance they are very appealing.
We have nothing like this here.
We Need That Cash Component
Given the availability of Traditional and Roth IRAs, I don’t think introducing the stock and shares component of the ISA would add much (though brokers would probably love it!) but the cash component is something we should think about.
Imagine if some of those high yield savings accounts offered tax free savings accounts, like these ISAs. The prevailing rate of 3.50% APY at FNBO Direct would be the equivalent of 4.67% APY for someone in the 25% tax bracket.
We need to start incentivizing people to save, rather than incentivizing people to spend. The economy may be hurt in the short term but will be greatly strengthened in the long term.
What do you all think?