Earn 5% on your savings, tax-free

One new ISA offers a whopping great rate of tax-free interest. But there's a catch...

The problem with many savings accounts at the moment is that, while they may be the best in their particular marketplace, the rates on offer are not exactly the sort to set the paces racing.

As I explained in Highest ISA rates in years!, it’s great that the interest on offer from ISAs is at a two-year high, but the fact that the average rate is a paltry 2.27% is hardly enough to have us all falling over ourselves in a mad rush to snap them up.

However, there are accounts now hitting the market with initial rates that may be enough to awaken you from your savings slumber.

Earn 5% - with a catch

Skipton Building Society last week laid down the gauntlet with the launch of a new cash ISA paying a whopping 5% return on your cash. When you consider that rate of interest is completely tax-free, it becomes even more enticing.

Related blog post

• John Fitzsimons writes:

  It pays to fix your savings

  Guest blogger Richard Brown of first direct looks at how to get the best return from your savings.

  Read this post

Should you put your full cash ISA allowance for the 2011/12 tax year of £5,340 into the Skipton ISA, then by the conclusion of the tax year you should be looking at a balance of £5,607 – interest of £267.

Of course, things are a little more complicated if you want to take advantage of this account – you’ll need to lock your cash up with Skipton for FIVE YEARS.

That’s an awfully long time to commit your cash to an account, particularly at the moment. With base rate at its record low of 0.5%, it is only going to head upwards, and it’s probably fair to presume that when it heads up, the rates on offer from savings accounts will do so too. So while 5% looks a fantastic rate in 2011, after a couple of years of base rate rises, by 2013 it might start to look awfully mediocre.

That’s the worst case scenario of course. It may be that base rate does increase, but at such a slow rate that by the time 2016 comes along, you’ll have earned more interest at 5% for five years, than by chopping and changing with new accounts every 12 months. You'll have to work out for yourself what you think is more likely to happen.

The Gold ISA

Personally, I’m a much bigger fan of the new Gold ISA from Barclays. This account pays a more modest initial rate of 3.25% AER, including a 1% bonus for the first 12 months. This is a market-leading rate in its own right, but the bank also deserves praise for its Barclays Rate Promise – that the interest rate on offer from its savings accounts will move in line with any changes to base rate up to March 2012.

It’s looking ever more likely that there will at least be a couple of base rate rises in that time, so you won’t be missing out on too much in interest compared to the Skipton ISA, and what’s more you’ll have the flexibility to move your money wherever you want to in a year’s time!

The e-ISA

A third new account launched in the last week worth a look is the e-ISA from Barnsley Building Society. The account pays a market-leading rate of 3.50%, but again this will involve you signing your cash away, though with Barnsley that is only for two years.

It’s a good rate, and the account can be opened online from as little as £500. There’s a decent chance that, for the first year, the Barclays Gold ISA will give it a run for its money. However, once the 12 month 1% bonus expires on the Barclays ISA (as well as its rate promise) then it’s unlikely it will offer the same second year value as the Barnsley e-ISA.

Fixing for the long term

So, if you want to take advantage of a fixed, tax-free rate on your savings, below is a collection of some of the best three, four and five-year cash ISAs in the market today.

Keeping flexible

However, personally I’d prefer to keep my saving options open. So in the table below I’ve detailed the accounts paying the best rates of interest on accounts of two years or under.

Using your full allowance

Of course, ISAs are about more than just cash. You actually have a £10,200 ISA allowance overall – no more than half of that allowance can be saved in cash, but you can save up to the full allowance in stocks and shares if you’d prefer.

Many of us don’t take advantage of this side of ISA saving – four times more cash ISAs were opened last year than stocks and shares ISAs. However, time it right  - and stick with it for the long run – and you could end up enjoying an even better return on your money than from a cash ISA. Have a read of Quadruple the return on your savings! for more.

More: Get a great ISA | Six financial things you should do this spring | Top 10 ISA myths