Don’t jump from frying pan into the fire in your bid to escape negative interest rates
The notion that ordinary savers could be charged to leave their savings in a bank has alarmed many — yet this is exactly what would happen if customers are hit with negative interest rates.
There are growing concerns that personal customers could be hit with negative interest rates later this year. The upcoming withdrawal of Ulster Bank from the Irish market has added to these worries as some believe that the exit will prompt Irish banks to move more generally towards negative interest rates on deposits.
Negative interest rates could be the final straw for savers who have already had to swallow near-zero or zero deposit interest rates in recent years.
Five years of negative interest could knock a few grand off your savings, depending on how much of a lump sum you have. For example, a negative interest rate of 0.65pc would take a €650 bite out of a €100,000 lump sum after one year — reducing it to €99,350 (assuming the negative interest is charged on the entire balance), according to Nick Charalambous, managing director of the financial advisers Alpha Wealth.
At that rate, a €100,000 lump sum would be eroded to €96,792 after five years — allowing for the impact of negative compounding, added Charalambous. (Negative compounding is where negative interest reduces your initial lump sum — causing the lump sum to deteriorate year after year.) So in this case, negative interest would have cost a saver more than €3,000 after five years.
When could ordinary savers be hit?
Since the European Central Bank (ECB) started to charge banks to deposit money with it almost seven years ago, the Irish banks have been increasingly trying to cover the costs of holding customer deposits. So far, most of the Irish banks have tried to recoup these costs by charging negative interest rates on the large deposits of business customers.
This could soon change.
“I firmly believe the mainstream banks including AIB and Bank of Ireland will charge negative interest rates on personal deposits either between July and September — or between October and December — of this year,” said Charalambous.
Alan Fearon, head of investments with Finance One, also believes that negative interest rates could be introduced for personal customers in “the latter part of the year”.
Which savers could be hit?
Savers will small amounts on deposit are likely to escape negative interest rates – however savers with deposits of €50,000 or €100,000 and higher could get hit, according to some investment experts. “I expect banks to introduce negative rates on larger accounts first — probably for accounts in excess of €100,000 — or €200,000 for joint accounts,” said Vincent Digby, managing director of Impartial.
Charambulous believes personal customers with deposits of €50,000 or more could get hit with negative interest rates.
It could be the case that only customers opening new deposit accounts will be hit with negative interest — if the banks follow in the footsteps of the German digital bank N26.
Last November, N26 became the first bank in the Irish market to charge personal customers negative interest rates on deposits. Since then, N26 has charged a -0.5pc negative interest rate to all new customers who have deposits exceeding €50,000. Customers who had deposits with the bank prior to November 2020 are exempt from the charge — as are N26 Metal customers. “This charge only affects deposits above the €50,000 cap — meaning if a customer has €52,000 on deposit, then the 0.5pc interest rate will only be applied to the additional €2,000, not the entire €52,000,” said a spokeswoman for N26. The negative interest rate is being charged to cover the cost to the bank of holding customer deposits with the ECB — which charges -0.5pc interest.
Savers with a regular saver account, as opposed to a large lump sum to deposit, could escape negative interest rates.
“There is no doubt that Irish banks do not want your money at present and they will do whatever [they can] to discourage you from opening new deposit accounts by bringing in caps [on the amount that can be saved], extra charges and negative interest rates for retail customers with relatively larger deposits,” said Fearon.
“New personal customers with significant deposits may start seeing negative rates being offered. However, I believe the banks here will not want to drive young savers or long-term customers away to new money transmission providers — for what may be a short-term position.”
Are negative interest rates inevitable?
The economic recovery anticipated for this country in the second half of this year could stave off negative interest rates for ordinary savers. Irish bank lending has fallen throughout the pandemic but lending is likely to pick up again once the recovery begins. “If the banks can start lending again, they'll need deposits,” said Fearon. However, any long delay to — or stinted — recovery won't bode well for savers.
The Irish banks say they have no plans to hit personal customers with negative interest rates — though most of them also state that they are keeping this “under review”.
Permanent TSB does not charge personal or business customers negative interest rates on deposits.
Banks could bring in savings caps for personal customers instead of — or in advance of —negative interest rates. Savings caps are one way the banks can address the cost of negative interest rates. Last November, EBS, which is part of AIB, became the first Irish bank to introduce a cap on customer savings. The cap is €500,000. Other banks are likely to follow suit. Most credit unions have already had savings caps in place for some time.
Dodging the negative interest bullet
The prospect of negative interest rates has prompted many to eye up alternative homes for their lump sums. You may for example be tempted to move your lump sum to an overseas bank account in Europe. There are some European banks that pay more than 1pc interest on deposits and you can access such banks through online savings platforms such as that offered by the German bank Raisin.
Irish savers however should be careful about moving deposits into overseas bank accounts. Be sure to check out the credit rating and size and strength of any overseas bank that you are considering moving your deposit to — as well as the extent to which your savings are covered by a deposit protection scheme (where your savings are protected in the event that the bank holding them goes bust), advised Fearon.
Digby doesn't believe that putting money into a foreign bank account is worth the risk.
“It's often hard to follow the progress of banks in different countries — and to know if the bank has been been downgraded or if it is in trouble,” said Digby. “Even if your deposits are covered by a deposit guarantee scheme, it could take many months to get your funds back if something goes wrong.”
Be aware too that you must notify the Revenue Commissioners if you open a foreign bank account.
Better use of savings
Another way to avoid negative deposit rates is move your money into an investment fund or product with some exposure to stock markets. This however could be a mistake. “Make sure not to jump from the frying pan into the fire,” said Digby.
You don't have to move your savings into an investment product to dodge the negative interest rate bullet. “See if there are risk-free ways of putting your savings to better use instead,” said Digby. “Repay credit card debt, personal borrowing and mortgages in that order.”
You could also redirect some of your savings into your pension, advised Digby. Pensions are one of the most tax-efficient ways of saving. “Make sure you are maximising pension contributions to get the full benefit of any [pension] tax relief,” said Digby.
Another possible way to put your savings to better use is to start a savings or investment plan for your children or grandchildren — taking advantage of the annual small gift tax exemption when doing so, advised Digby. With this exemption, any individual can receive a gift up to the value of €3,000 from any person in any calendar year without having to pay Capital Acquisitions Tax (the tax typically paid on gifts or inheritances).
Remember, if you have decided to put any build-up of savings to other use, keep some of it to hand in case you need it to tide you over at times of emergency, unexpected problems, or when income is unexpectedly low.
For those seriously considering moving into investments, only do so if you can stomach stock market volatility. “Leave enough aside for a rainy day and then don’t panic if markets do drop - as they did last February when Covid first hit,” said Fearon. “One size does not fit all. If the thought of any drop keeps you awake at night, maybe investing in anything outside deposits is not for you.”
KNOW THE RISK
Most investment funds and products have a risk rating which indicates how much risk an investor takes when putting money into them. That rating typically ranges from one to seven. An investment with a risk rating of one will have a very low chance of losing money on the stock markets, but will also deliver low (if any) returns. An investment with a rating of seven will be a very high-risk product with the potential to deliver high returns, as well as high losses. Know the risk rating on your investment — and what it means for you.
For an individual who wants to move a large lump sum (say €100,000) from deposit into an investment product, and who is unwilling to take too much risk with his money, Zurich Life’s Easy Access Bond was recommended by Alpha Wealth’s Nick Charalambous.
You can invest in Zurich’s Prisma funds through this bond — and you can choose a fund which suits your appetite for risk. Charalambous suggests the Prisma 2 or Prisma 3 fund for a cautious investor. The Prisma 2 fund has a risk rating of three (low-to-medium risk) — while the Prisma 3 fund has a risk rating of four (medium risk).
The Easy Access Bond is also an option for an individual who is willing to take a medium amount of risk with €100,000, advised Charalambous. However in this case, the investor would use the bond to invest in the Prisma 4 fund which has a risk rating of five (medium-to-high risk).
A low-cost multi-asset fund — where you typically get a mix of bonds and equities in one fund — is another option for an individual willing to take on medium risk, according to Vincent Digby of Impartial.
“Have your adviser look at the performance of the fund in previous periods of volatility — such as 2008/2009 or 2020 — to see how much a fund with 60pc equities and 40pc bonds, fell and how long it took to recover,” said Digby. “If that looks too scary, then move it to a fund with 50pc equity 50pc bonds — until you get an option where you will be prepared to ride out any bad times in future years.”
Digby tipped a low-cost passive fund provided by the likes of Vanguard or Dimensional Fund Advisors. (A passive fund typically tracks a segment of the stock market.)
Understand the charges on and taxes of any investment — and how those charges could eat into your lump sum and any return you make. You must usually tie up your money in an investment for at least five years to have any chance of making a return — and to avoid any early exit fees (if charged). “If you aren’t happy to leave the funds invested for at least five years, then moving from deposits to higher-risk-and-return investments might not be for you,” said Digby.
Always get independent financial advice before investing a large lump sum.