Take this chance to earn 6.6% on your savings

Robert Powell takes a look at a new account that offers you a huge inflation busting return on your savings...

Protecting your nest egg is difficult in the current climate. With the Retail Price Index inflation rate (RPI) now running at 5.1%, fewer and fewer accounts are able to offer a return that will stop your savings being eroded by the rising cost of living.

Fortunately the savings sector is starting to catch up with public demand. Last month we reported on the first of the tailored inflation busting accounts; BM Saving’s 5 Year Inflation Rate Bond. This account pays 0.25% on top of RPI so you’ll stay ahead of inflation before tax, but will still lose out after.

But you can now get your hands on an account that pays a whopping 1.5% above inflation - making it much easier for basic rate taxpayers to beat tax and inflation, in one fell swoop.

The Post Office Inflation Linked Bond

The Post Office’s Inflation Linked Bond pays 1.5% on top of the reading of RPI taken in April every year and published in May. So if RPI is read at 5.1% in April 2012, you’ll earn 6.6% on your savings.

If any of the yearly inflation readings are zero or slip into deflation, you’ll earn 1.5% for that year. You’ll have to lock into the bond for five years from 26th May 2011 and the interest is paid gross when the account matures on 26th May 2016.

It’s important to point out that the inflation figure published each May relates to price rises over the previous 12 months. As a result, the first indication you’ll have of the interest rate you’ll receive in the first year of the bond's life will be in May 2012 – as this figure will relate to inflation between April 2011 and April 2012.

That means you'll earn 6.6% if inflation stays at its current level right up to April 2011. You could earn more if prices continue to rise or less if prices drop, but your rate will never fall below 1.5%, no matter how low prices drop.

So I could earn less than 6.6%?

Yes, you could, and that's certainly one of the downsides to bear in mind before you open this account, especially because the Government has targeted the Bank of England to keep inflation at around 2%, which - if the Bank's efforts are successful - would mean only a 3.5% return.

In reality, despite the Government's target, inflation is predicted to rise, at least in the short term. And while this account is by no means perfect, it offers the best chance you have of earning 6.6% in the current climate, when even market-leading savings accounts are only paying around 3%. It's a great option if you're not interested in chasing the best rate, but simply want the peace of mind that comes with a savings rate guaranteed to beat inflation before tax.

Here’s a table showing how the yearly and total interest rates are calculated in relation to a changing RPI reading...

Bear in mind that if inflation rises above 6%, basic rate taxpayers will no longer be able to beat both tax and inflation using this account - they will only beat inflation. Until inflation hits that point, you are guaranteed to get a real return on your savings!

Who should take out this account?

This account is really aimed at savers with one large lump sum that they definitely won’t need to get at for five years. The minimum deposit is £500 and the maximum is £1m and you are not allowed any additional withdrawals or deposits within the five years. If you’re planning on using your savings as a regular income then this account won’t be suitable as the interest is paid at the end of the fixed term in one lump sum.

But if you’re just after an account that will lock up and protect your hard earned pennies from inflation for a long period then the Post Office Inflation Linked Bond is the best account I’ve seen since the exit of the lovemoney.com favourite NS&I Certificate!

If you are planning on going for this bond you need to get your skates on as it’s only available until 27nd April 2011 and it will be withdrawn early if it's oversubscribed, which is quite likely as it's been featured heavily in the financial press this week.

Saving alternatives

The Post Office isn't the only savings provider jumping on the inflation bandwagon. As I mentioned earlier, BM Savings also offer an inflation linked account that pays 0.25% over RPI and last week, Yorkshire Building Society released its own inflation linked product; the five year Protected Capital Account.

This account is separated into two versions:

1) The maturity return version (Linked Plan 2) offers a one-off interest payment of the percentage increase in the RPI figure over the five years, plus 1.5% on maturity. This might sound the same as the Post Office Bond, but it actually works out at just 0.29% AER. 

2) Alternatively, the annual income account (Linked Plan 1) guarantees interest equivalent to the yearly RPI reading plus 0.1% AER and is paid into a separate account every year.

Clearly, neither of these accounts pays as much as the Post Office Bond and you will need to deposit a minimum of £3,000.

The only good news is that, with both these accounts, you can invest your 2010-2012 Cash ISA allowance (£10,440), as well as transferring in any existing ISAs from previous tax years. So you can be certain you will avoid paying tax on the interest you receive and are guaranteed a small but real return after both inflation and tax.

The maximum investment on this account is £85,000, so if you don’t fill all of this using your Cash ISA allowances (and you’d have to have saved hard to be able to do so!) you can also make a standard deposit. Although you’d obviously have to pay income tax on any interest earned from this part of the investment.

Easy access alternatives

As far as easy access savings accounts go, the situation isn’t looking too rosy.

The Coventry BS eNotice offers 3.05% but you will need to give 30 days’ notice before making any withdrawals (read New market-leading savings account to find out more).

So for true easy access, your best option is the Nationwide Building Society MySaveOnline Plus account, which pays 2.95%.

However, this rate is variable, so it could fall. By contrast, the ING Direct Savings Account offers a fixed rate and instant access, and its rate is only 0.15 percentage points lower at 2.8%. 

When inflation is raging at 5.1%, these are slim pickings indeed.

There is an alternative however. As long as you're prepared to jump through a few hoops and put up with a bit of hassle, you can earn up to 5% on your savings and still have easy access. All you have to do is switch your current account - take a look at this table:

As you can see, all these current accounts offer a far better return than the easy-access savings accounts. Just bear in mind that you will need you to pay £1,000 in every month to qualify for the high interest rate or cashback on each of these accounts (plus Santander will make you transfer over all your direct debits). Both the Santander and Halifax offers are also ending soon - so you'll need to act fast if you want to pick up these accounts!

Read The best current accounts for 2011 to find out more or compare deals using our current account comparison tool.

More: Get a great savings account with lovemoney.com | Get your hands on some extra cash | Earn up to 9% on your savings