This tax-free account beats inflation

NS&I has thrown savers a lifeline by announcing the re-introduction of its popular index-linked savings certificates.

The world of savings has been a dark and gloomy place of late. Rising inflation and paltry interest rates have made many wonder if they should even bother taking out an account at all!

And as I reported last week, even if a savings account looks to be offering a good rate, there’s a fair chance that its attractive facade will only be a 12 month bonus. And once that drops away, your interest rate will plummet.

In fact, the situation has been so dire that some of the best interest rates available to savers have actually been on current accounts! Take a look at this table if you don’t believe me...

Madness!

But hidden deep within last week’s Budget was a glimmer of hope for those tormented souls currently inhabiting the dark, baron wasteland that is savers-ville.

Intrigued? You should be...

NS&I to the rescue!

Yes, the index-linked savings certificates from NS&I are set to make a return!

For those not in the know, NS&I savings certificates typically pay 1% over the rate of inflation, as measured by the Retail Price Index (RPI). And what’s more, the interest is paid tax-free meaning you can be positive that rising prices won’t get at your savings!

So with RPI currently sat at 5.5%, those lucky savers who took out the certificate last year before NS&I withdrew them will currently be earning 6.5% on their nest-egg.

And what’s more, as this certificate is not an ISA you won’t have to use up any of your annual ISA allowance when taking it out. In fact, you could invest in the NS&I certificate as well as stashing money away in an ISA and benefit from two tax-free income streams!

You can also be confident that your cash will be safe as NS&I is owned by HM Treasury and backed by the British Government.

Hazy savings

Unfortunately NS&I is being fairly hazy about the exact details of the savings certificate’s return. All it has said so far is that it hopes to re-open applications in the next financial year, but hasn’t confirmed exactly when. Although the FT was reporting last week that they could make a return as early as May.

The precise rate that the certificate will pay is also still unclear. As I mentioned earlier, interest on the account is typically set at 1% over RPI, but with inflation currently so high and the squeeze on the public purse so tight, it wouldn’t be at all surprising if NS&I dropped this rate.

We explained exactly how the certificate worked last year in This account pays 6.3% on your savings – tax-free – but remember, there’s no guarantee that the re-launched account will be identical to the 2010 issues.

Other options

If you really don’t want to keep hanging on for the NS&I re-launch, there are a few other options that will give you an index-linked return on your savings. They’re not tax-free but you may still be able to beat inflation if you're a basic rate taxpayer.

Last month, BM Savings launched two new inflation-linked bonds paying 1.50% over RPI on a five year fixed term and 0.75% over RPI on a three year fixed term. The interest is calculated using the April RPI reading each year and paid into the account annually on the anniversary date of the bond.

To be eligible for this rate you will need to open the account by 16 May 2011 and pay in a minimum of £500 (the account has a £1m maximum).

The Post Office is also offering an almost-identical five year bond that pays 1.50% over RPI with a minimum deposit of £500. Again, annual interest rates are calculated using April’s RPI reading and the interest is paid in one lump sum when the bond matures in 2016. This account stops taking new applications on 27 April 2011 – or earlier if it is oversubscribed.

Both of the five year accounts I've mentioned here (from BM and the Post Office) guarantee a minimum interest rate of 1.50% (0.75% if you opt for the BM three year bond) and will keep you ahead of both tax and inflation, so long as RPI doesn’t exceed 6%.

To find out more about both of these accounts, read Take this chance to earn 6.6% on your savings.

Worth locking in?

As is the case with all savings accounts, you’ll get the best interest rate if you’re prepared to lock away your cash for a long time. NS&I has typically offered a three and five year account, but as we mentioned in our last article on the certificate – the early access fees are actually comparatively low.

The danger with locking your savings away for a long time is that if the Bank of England base rate does rise – as many expect it to – then savings rates will head skywards and inflation will drop. This will see your index-linked bond starting to look very uncompetitive when compared to a new batch of rejuvenated savings accounts.

So if you’re something of a rate-tart, determined to get the best return on your savings at all times - a long term bond is probably not a good idea. But if you just want the peace of mind that your cash will always be one step ahead of inflation, an index-linked account may be for you.

What do you think?

Is it worth locking into a savings account for a long period of time? Or do you think that the base rate will rise soon? How long would you stash your savings away for?

Let us know your thoughts in the comment box below.

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