Savings Accounts That Shrink Your Stash

Is it really such a big deal if the interest rate paid by your savings account isn't up to scratch? After all, your money is safe and growing, isn't it?

This article was sent to Fools as part of our 'Good, Bad and the Ugly' email series. 

Is it really such a big deal if the interest rate paid by your savings account isn't up to scratch? After all, your money is safe and still growing, isn't it?

Alas, thanks to inflation -- the tendency of goods and services to cost more over time -- it could be that your savings are shrinking. In other words, the rising cost of living means your money will buy less next year than it does now. Thus, your savings rate needs to keep pace with price increases, or else your pot buys less.

The government's preferred measure of inflation, the Consumer Prices Index (CPI) stood at 2.2% in January. However, the CPI calculation omits vital housing, energy and food costs, all of which are rising strongly at present. Thus, I prefer to measure inflation using the Retail Prices Index (RPI), which currently stands at 4.1%, or twice the CPI figure.

Hence, unless your savings are growing at a yearly rate of at least 4.1%, then your money is actually shrinking in `real' terms (after taking inflation into account). An added complication is that 4.1% is your after-tax return, because most adults pay tax on savings interest. A notable exception is the tax-free interest paid by cash Individual Savings Accounts (ISAs) and certain National Savings & Investments accounts.

If you are a basic-rate taxpayer, then you surrender a fifth (20%) of your before-tax savings interest to HM Revenue & Customs (HMRC). Thus, in order to earn 4.1% a year after tax, you need to earn 5.13% a year before tax. For higher-rate (40%) taxpayers, this pre-tax hurdle is 6.83% -- a rate barely matched by the very best fixed-rate bonds.

Now take a look at the following table, which lists the highest-paying accounts with easy access, no withdrawal restrictions and no introductory bonuses. To me, these are the leading `no strings' accounts right now:

Best Buy easy-access savings accounts for £1+

Source: Fool.co.uk's independent, unbiased search engine

As you can see, keeping your cash in a table-topping account should enable you to beat inflation and see your savings grow. However, at the other end of the savings spectrum lie some truly awful accounts. These pay such pitiful rates of interest that the value of your money is dwindling with every passing year:

Don't Buy easy-access savings accounts for £1+

Source: Fool.co.uk's independent, unbiased search engine

In these tenth-rate accounts, your after-tax savings rate -- on small sums -- is effectively zero. Thus, any spare cash stashed in these accounts shrinks like a woollen jumper in a boil wash!

As a former marketing manager in financial services, I would argue that these should not be labelled as savings accounts. That's because, thanks to their trivial interest rates, your money is guaranteed to shrink over time. Indeed, it's beyond me that banks and building societies get away with paying no interest whatsoever on smaller sums of cash. Frankly, savers with money in these -- and dozens of similarly atrocious accounts -- are being taken for a ride.

Finally, if your nest egg, emergency pot or rainy-day money isn't earning a decent rate of interest, the simple answer is to ditch and switch. Personally, I'd steer clear of any savings account which pays a lower rate than the Bank of England base rate, currently 5.25% a year. Indeed, my advice is to move your stash to a Best Buy account today!