Not so enticing inflation protection

By Maike Currie, 12 April 2011

With inflation rising and interest rates remaining stagnant at near zero, I was enticed by an inflation-linked cash individual savings account (Isa) offer that landed in my inbox.

The five-year cash Isa from krbs (the trading brand of OneSavings Bank, which maintains strong links to Kent Reliance Building Society) offers savers a return of 2 per cent plus the change in the retail prices index (RPI) if they hold the account until maturity - 31 May 2016.

Since the withdrawal of NS&I index-linked certificates, savers have been hunting for alternatives to protect their savings from inflation. RPI-linked savings bonds are one option, but the krbs product offers inflation-linked returns within a tax-free wrapper, thereby replicating the tax-free status of NS&I Index-Linked Savings Certificates.

The answer to investor's woes? Not quite. As Justin Modray of Candid Money points out, on the surface the inflation-linked Isa sounds attractive, but compared with NS&I Index-Linked Certificates and the inflation-linked accounts from BM Savings and the Post Office, there are drawbacks.

Firstly, the inflation-linked return is calculated over five years rather than yearly, meaning savers will lose out if we experience a period of deflation.

Granted, that doesn't look likely right now, with inflation running at double the Bank of England's target. But you never know. Say inflation rises by 5 per cent in each of the next two years then falls by just over 3 per cent in each of the following three years, the Isa's inflation-linked return would be pretty much nothing, as RPI at the end of year five is more or less where it started in year one. An account that locks in inflationary returns each year would return an overall inflation link of 10 per cent.

Secondly, the 2 per cent bonus above RPI is a one-off bonus over the whole period. On a per-year basis, it's equivalent to just 0.39 per cent. This looks poor value compared with accounts that pay higher annual bonuses.

Inflation-linked accounts from BM Savings and the Post Office are taxable, so the krbs Isa might appeal to higher and top-rate taxpayers, who have few other ways to beat inflation on cash savings. But that might all change next month, when NS&I reintroduces Index-Linked Savings Certificates. I'd be inclined to wait and see what they come up with first.

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