Earn An Inflation Busting 12% On Your Savings!

Fancy a fantastic double digit return on your savings? Here's how to get it.

Uh oh. Figures out this week revealed the rate of annual inflation, as measured by the Retail Prices Index (RPI), has jumped from 4.6% to 5%.

This is bad news for savers, especially tax-paying savers, who want to protect their savings from the ravages of inflation and the tax-man. So what can you do to fight back against these two powerful foes?

Earlier this month, I wrote how savers could get a top notch return of over 9% a year via an index-linked savings certificate from NS&I. Today I can go one better. How do you fancy a return of more than 12% on your hard-earned cash? 

Leeds Building Society has just launched a new inflation busting cash ISA, which has a fixed term until September 2010. As long as you have at least £1,000 to save, the account provides a return that is guaranteed to beat inflation -- as measured by the Retail Prices Index (RPI) - by 2.25%. So you can be sure to earn a real return that keeps ahead of the RPI until the ISA matures.

Even better, if you like the idea of inflation-linking old ISAs which were opened in previous tax years, then the Leeds account accepts transfers in too.

So what might you get back?

The actual return you'll get is based on the change in the RPI over the fixed term of the ISA*, but if we take the RPI at the current rate of 5% and add the bonus, the Inflation Buster ISA could provide you with a return of 7.25%. But because ISAs are tax-free, that's equivalent to an impressive 9.06% for basic rate tax payers and a whopping 12.08% for a higher rate tax payers.

Now that's going to be hard to beat! Even the market-leading easy access cash ISAs -- such as HSBC's Cash e-ISA or Barclays' Tax Haven ISA -- can't quite compete with top rates of 6.25% AER tax-free.

But, of course, with a return this good there are catches:

Firstly, the ISA has a fixed term. To fully benefit, you'll need to leave your savings in the ISA until 30 September 2010. Withdrawals and transfers to another ISA provider are permitted, but the return could be lower. So I wouldn't go for this account unless you're happy to lock your money away for the next two years.

Secondly, the term runs from 1 October 2008 to 30 September 2010. Cash invested now will only earn a rate equivalent to the base rate (currently just 5%) until the 1st October, when the rate will change.

Still, if you want this account, it's probably a good idea to open it now in case it becomes oversubscribed in October.

And finally, if inflation falls over the term, your rate will fall. So there is a risk you'll be better off choosing an ISA with a fixed rate that isn't linked to the RPI. However, inflation is not predicted to fall dramatically in the near future - in fact, some economists believe it will continue to rise.

What happens if inflation is very high?

Quite simply, you'll keep ahead of the RPI, however high it rises over the term. If the RPI increased by 12%, for example, your return would be 14.25% tax-free.

Remember you can only invest £3,600 into a cash ISA this tax year, but there's also an opportunity to put further savings into Leeds Building Society's Inflation Buster Bond. The return is the same as the Inflation Buster ISA except that it is taxable. So based on the current RPI, you could earn 7.25% gross.

That puts the bond ahead of the market-leading instant access account from Kaupthing Edge which pays 6.55%.  But there is a price to pay for the higher rate because you can't make any withdrawals at all until it matures.

If you don't need to get your hands on your cash, I think the Inflation Buster accounts are worth considering. But I question whether a return linked to the RPI is good enough to truly beat inflation. After all, research here at The Fool found that the real rate of inflation is running much higher than 5%, with Fools claiming the rise in the cost of living is nearly double at 9.3%**.

That said even if the Inflation Buster ISA can't beat the real rate of inflation, it could still offer one of the best returns on your savings, particularly if the RPI continues to climb.

*The change in the RPI is measured between 30 June 2008 and 30 June 2009 in year one and 30 June 2009 and 30 June 2010 in year two.

** As at June 2008.

More: Earn 6.55% on Your Savings | ISAs Beat The Credit Crunch | Visit The Motley Fool ISA and Savings centres.