Earn the highest rate on your savings

With rising living costs eating away at your savings, Robert Powell takes a look at the top paying accounts and whether it's really worth switching.

It’s been a pretty rotten 12 months for savers.

So bad, in fact, that many people’s nest eggs have begun to crack. It’s estimated that anyone who had £10,000 in the average savings account would have lost £331 as a result of soaring inflation and record low interest rates last year.*

But is there anything we can do to fight back against inflation?

Savings accounts

The latest inflation figures show that the Consumer Price Index jumped 0.4 percentage points during December to 3.7%. This is bad news for savers as it translates as an assault on the direct spending power of cash kept in savings.

To beat rising inflation, a basic rate taxpayer at 20% now needs to find an account that pays 4.63% per year, while a higher rate taxpayer at 40% has to find an account paying at least 6.17%.

Unfortunately, there aren't any savings accounts that pay 6.17% or more. And out of the 2,203 savings products on the market at the moment there are only 22 that pay more than 4.63%. 

The good news is, 19 of these accounts are ISAs, which means they beat will inflation, whatever your income tax band. 

Savings accounts

First I'll take a look at the savings accounts. Here’s a table showing the three savings accounts that will beat inflation for basic rate taxpayers, although sadly not for higher rate taxpayers:

These three accounts will allow you to stay ahead of inflation, but as you can see they also come with some pretty awful strings attached.

As their names suggest the Yorkshire and Barnsley Building Society combination bonds are issued as part of a savings and investment combination. So to get your hands on the high rate savings account you’ll need to stump up £5,000 for a longer term investment with Legal & General. And that’s on top of the minimum £1,000 that you’ll need to deposit in the savings account.

Remember that any investment is a risk. So, if all you're looking for is a safe home for your savings, here at lovemoney.com, we think you should steer well clear of these combination bonds. And even if you're looking to invest your money, it still might not be the best option for you. Read Avoid these scandalous savings accounts to find out why.

How about the third account in this table - the Coventry Building Society  Bond? You’ll be able to deposit anything from £1 into the Coventry Bond but you’ll need to be sure that you won’t need to get at your cash until 2016. Any withdrawals made before that date will see you lose 180 days of interest payments. And, as interest rates are likely to rise in the next five years, you may you've locked into an uncompetitive rate. (More on this below.)

So in terms of inflation busting savings accounts, the options are few and far between for basic rate taxpayers, and obsolete for 40% taxpayers.

But there are other options...

ISA

As ISAs are not subject to tax while being held or withdrawn, they make a better choice for savers wanting to beat rising costs.

There are 19 ISAs that pay interest above the 3.7% Consumer Price Index of inflation, here are five of them:

As you can see there are several deals out there offering a top rate of 4.30% for a minimum investment of £500 and 4% if you can only stump up £100. But you will need to lock away your cash for around three to five years, and that might be a bad idea.

Interest rate rises

Spiralling inflation has led many people – including lovemoney.com’s own Harvey Jones – to call for the Bank of England to up the base rate from its current 316 year low of 0.5% (you can read why here).

Now while it’s debatable what overall effect this would have on the economy, what’s certain is that it will push up the interest rates of savings products. So if you’ve locked into a four year ISA or taken out a lengthy fixed rate savings account you may find yourself stuck with a comparatively rubbish interest rate.

It’s effectively the inverse problem of the to-fix or not to-fix mortgage dilemma that John Fitzsimons reported in If you don’t fix now, you’ll regret it.

It used to be possible to get round this problem by using the National Savings & Investments index-linked savings account. This is a variable account where the rate alters with the Retail Price Index, ensuring you’re always ahead of inflation. But unfortunately NS&I withdrew this account last year – but it may be back soon!

5% current account

Ironically, one of the best deals for savers looking to stay ahead of inflation is actually to get a current account – the Santander Preferred In-Credit Rate Account, to be precise.

Now I know that many lovemoney.com readers aren’t massive fans of Santander – and if several comments are to be believed their ‘hassle-free’ current account switching service really doesn’t live up to its name – but as far as interest rates go, this account is a good deal!

You’ll earn a whopping 5% on balances up to £2,500 (but nothing on anything above that) for the first 12 months as well as getting £100 cashback when you switch, plus you'll get easy access to your savings and the security of a high fixed rate. There are two catches:

• 1) that you will have to pay £1,000 into the account every month and
• 2) you must transfer at least two direct debits or standing orders using the Santander Switching Service, within the first 11 weeks of opening the account.

But if you're prepared to jump through the hoops, it’s a good option if you have less than £2,500 in savings, a monthly wage above £1,000 and you believe that the base rate will increase in the next 12 months.

For some more tips on maximising your savings read Earn 10% on your savings and New market-leading savings account.

Get help from lovemoney

For great how-to guides, explaining everything from how to cut your mortgage costs to how to make money in every room of your house, head over to our Guides section.

If you need help with a specific issue, why not see if your fellow lovemoney.com users can help by asking a question in our Q&A section?

*According to moneysupermarket.com, savings accounts paying an average rate of 0.19% would have lost £331 as a result of the rising cost of goods and services in 2010.

More: The best savings accounts for 2011 Why we should all save like a Welshman