Don't give up on your savings!

Inflation is the enemy of savers. The interest rate you're earning on your account at least needs to match the rising cost of living, otherwise the purchasing power of your savings is being steadily eroded. That's why it's so important to move your money to find the best deal.

April saw the rate of inflation drop to 2.4% - down from 2.8% in March - which is positive news for hard-pressed British households. If you're a saver, it means there are more accounts out there that actually beat the cost of living.

Over the last year, we've seen the rates on savings accounts plummet. The main reason for this is the government's Funding for Lending scheme, which has provided banks with cheap money to lend to consumers. This means they no longer have compete with each other to attract deposits from savers.

So let's take a look at what 'inflation-busting' savings accounts are out there ...

Inflation-busting savings rates

The best savings rates are offered to those who are prepared to lock their cash away in a bond for a given period, or commit to regular saving over a defined term.

For instance, the Barclays Monthly Savings account offers a fixed interest rate of 3.25% (AER) for savers who can stick with the account for a 12-month period. You can save £20 to £250 a month. In any month that you make a withdrawal, the interest rate sags to 3.03%

The Leeds Building Society Regular Saver Issue 2 is another regular savings account with an inflation-beating rate of 3.05% (variable). As with the Barclays account, this can be opened with a £20 deposit and will need regular monthly deposits of between £20 and £500 thereafter. This account allows one penalty-free withdrawal to be made during the first 12 months.

The Furness Building Society Lifestyle Saver is also an option as this offers a rate of 3.00% AER (variable) and can be opened with a £1 deposit, after which monthly deposits of between £1 and £250 must be made.

If inflation is one spectre at the savings feast, tax is another. While there are other savings accounts on the market that are above the 2.4% level of inflation, you have to remember that the interest rates quoted are gross (without tax being deducted).

So, if you are a basic rate taxpayer and opt for an account that pays 3.00% AER, inflation will really start to bite as you'll lose 20% of your interest and you'll actually receive 2.4% net.

You can elude the tax man's clutches with an individual savings account (ISA), where you can save up to £5,760 each tax year and pay no tax whatsoever.  For example, Nationwide and Birmingham Midshires building societies are quoting 2.25% on ISA deals. You can check what the ISA market has to offer here.

 

Tax and savings

As mentioned, accounts are paid net of 20% tax. If you're a higher rate taxpayer you'll have to have to pay the extra tax due via your annual tax return.

So, to take the Barclays Monthly Savings Account as an example, while the gross AER is 3.25%, the net AER is 2.56% for basic rate taxpayers, which is still above inflation. But it drops to just 1.92% for higher rate (40%) tax payers and 1.76% for additional rate (45%) tax payers.

If you're a non-taxpayer (check our 2013/14 tax allowances guide) you can arrange to have your interest paid gross. You'll need to fill in form R85, which will be available from the institution concerned.

Alternative savings - Peer-to-peer

Peer-to-peer saving is growing in popularity due to the dearth of decent savings rates, but while it can considerably increase your return, there is also greater risk involved as your capital is not protected by the Financial Services Compensation Scheme (FSCS) that underpins traditional savings vehicles to the tune of £85,000.

All being well you could earn as much as 6.20% AER (variable) on a minimum investment of £20 if you chooseFunding Circle's product, while RateSetter offers fixed rates of 5.00% and 3.90% on its respective 5-Year Incomeand 3-Year Income products.

These products are potentially better alternatives for those in the higher tax bands who want to fight off inflation.

You can also get 3.00% on RateSetter's 1-Year Bond.

For a more detailed look at peer-to-peer savings, read Melanie Wright's article Peer-to-peer: The phenomenon taking savers by storm.

Alternative savings - Current accounts

Instead of opening a savings account, your best bet could be to switch current account as some are offering interest rates that compete with accounts high up in the savings charts.

For instance, the Santander 123 Current Account offers 3.00% AER on balances between £3,000 and £20,000,2.00% on balances between £2,000 and £2,999.99 and 1.00% on balances between £1,000 and £1,999.99.

This account also offers cashback on certain direct debits. So water bills, council tax bills and Santander mortgage payments earn 1.00%, gas and electricity bills earn 2.00%, while mobile phone, home phone, broadband and subscription TV packages earn 3.00%.

You will need to pay at least £500 per month into this account and there is a £2 monthly fee.

Alternatively, the Nationwide FlexDirect Current Account pays a fixed annual interest rate of 5.00% (AER) for 12 months on balances up to £2,500, provided that you pay at least £1,000 into the account each month.

Then there is the First Direct 1st Account that, once opened and provided you deposit at least £1,000 per month, gives you access to a regular savings account that offers an AER of 6%.

You'll have to make sure you take advantage of this savings account though as no interest is paid on your current account balance.

For more information on these and similar accounts, read Rachel Wait's article Maximise your savings... with a current account.

Beware the bonus period

Aside from the level of interest you earn, and any minimum or maximum deposits you can make, you should also look out for headline-grabbing savings accounts that are bloated with big temporary bonus.

Such accounts are fine during the bonus period, but once this ends the rate drops like a stone by the full amount of the bonus. The bank of building society will hope that you'll either not notice the removal of the bonus or simply not get round to moving your money. So try to take advantage of bonus periods while you can but be sure to move your money once the period expires - the banks are banking on you not bothering!

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.