Risk-free, high-interest savings accounts

Would you like somewhere safe and rewarding to stash your savings? Donna Ferguson has the answer.

Here at lovemoney.com, we are big fans of inflation-linked savings bonds.

Why? Because inflation-linked savings bonds guarantee you a return that will beat inflation. This means they are a safe and rewarding way to save over a medium to long period of time (usually you have to lock your money away for three to five years). You can rest assured that the value of your savings will not fall in real terms, whatever happens to inflation in the future. This effectively means that what you can buy today with your savings, you’ll be able to buy in the future, no matter how much prices may rise.

What’s more, your rate should always be relatively competitive. This is because, when inflation falls, interest rates typically do as well - and vice versa. So if your return beats inflation, it should always be broadly in line with competitive rates in the market. It is unlikely to be the most competitive, but it should be in the same ballpark.

This is despite the fact that the return on these bonds often seems low on the surface.

For example, NS&I offers a bond - which it calls a ‘savings certificate’ - that only promises to beat the Retail Prices Index (RPI) by 0.5%, which doesn't sound like much. But when you take into account that RPI in the month to June 2011 was 5%, and add in the fact that NS&I inflation-linked bonds allow you to save tax-free (even if you’ve used up your full ISA allowance), you can see the return is actually extremely competitive indeed.

In fact, higher rate taxpayers who invested money in this bond a year ago are earning the equivalent of 9.16% AER on their savings. It’s impossible to find any savings account paying that much today. And when you factor in that NS&I is backed by the UK Treasury, so the savings are 100% safe no matter how much you invest, you can see just how attractive these bonds can be.

The downside of these savings certficates

In my opinion, the only real downside of the NS&I bond (for taxpayers, at least) is that you can only invest £15,000 per certificate.

But if you are a non-taxpayer, you can get a better return. This is because a new certificate has recently been launched, which offers a better rate for savers who don’t pay tax. It is also worth considering if you’re a taxpayer with more than £15,000 to invest. It’s called the Cambridge Inflation Linked Bond, and promises to beat inflation (as measured by the RPI) by a whopping 1% AER, fixed for five years.

Here’s how the two certificates would pay after any applicable income tax is taken off, if RPI stays at its current rate throughout the term of the bond:

As you can see, if you don’t normally have to pay tax on your savings, you’ll earn a higher return if you opt for the Cambridge Inflation Linked Bond rather than NS&I. But if you do pay tax, even though the rate on the NS&I bond is 0.5% lower than the Cambridge Bond, you’ll earn a better return with NS&I, sheltering your hard-earned cash from the taxman.

In terms of safety, you can save up to £85,000 in the Cambridge Inflation Linked Bond and enjoy the same protection as savers with NS&I.

The big downside with the Cambridge bond is that you need to invest a minimum of £5,000 and you’re not allowed to make any withdrawals during the five year term. With NS&I you only need to invest £100, and you can take out your money at any time (although you will suffer a loss of interest). You can find out more details about the NS&I bond here or apply for the Cambridge Inflation Linked Bond here - you must apply before 15th September.

Before you rush off to apply, howvever, bear in mind that there is an even better inflation-linked bond out there for non-taxpayers: the Post Office Inflation Linked Bond Issue 2. This pays RPI + 1.5% on its five year term. This bond is backed by Bank of Ireland, but because it's sold under the Post Office brand, your savings will still be covered by the UK's FSCS safety net scheme. You have to apply by the 16th September. Just don't invest more than £85,000 - in theory, you can invest as much as £1m!

Of course, my table above assumes that inflation stays at its current level of 4.2%. Is this a fair assumption - and what will happen to your savings if it doesn’t?

The rate of inflation

It is impossible to accurately predict what will happen to inflation over the next five years. But you can take an educated guess - and many people do. Mervyn King, for example. He's predicting inflation will hit 5% by the end of next year, and he's the Governor of the Bank of England.

However, I don't like making long-term predictions. I'm happy to take a punt and join Mervyn in saying that inflation is unlikely to fall dramatically in the near future, but I wouldn’t want to make any predictions about where it will be in five years' time. Still, I wouldn’t let the unpredictability of inflation put you off getting one of these bonds. At the end of the day, these bonds are best suited for savers who are seeking a guarantee that their savings will safely go up in value, in real terms, over a five-year period. If that sounds like you, then you won’t care if inflation falls, because no matter what happens, your savings are guaranteed to still be worth more in real terms at the end of the term of the bond. And if that’s what you care about, more than always getting the best return, these bonds are for you.

These bonds are not, however, suited to savers who want the flexibility to react to what’s happening to the economy and interest rates and inflation in the short-term, and gamblers who like to chase the best returns year-by-year.

But if you want somewhere safe to stash your money away for five years - safe both in terms of the return you’ll get and the security of your cash - then they are a very good option!

What do you think?

Do you think these bonds are a good idea? What are your predictions for inflation and how will this affect the savings market? Let us know your thoughts using the comments box below! 

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Compare savings accounts, find out about about the NS&I bond or apply for the Cambridge Inflation Linked Bond