Earn 4.7% tax-free

by Donna Werbner on 16 February 2010  |  1 comment
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There's now an easy way to earn 4.7% tax-free on your savings, even if you have already used up your full ISA allowance.

The news today that inflation has soared to 3.7% will leave savers reeling.

There are now no easy access savings accounts and no one-year bonds which beat inflation. You have to commit to a two-year bond from ICICI Bank before you'll get an inflation-beating return - and even then, it's just 4.25%, so a measly 0.55% above inflation. And if you're a taxpayer, all that will get swallowed up in tax anyway.

In fact, to earn any sort of real return on your money - one that beats inflation after tax - basic-rate taxpayers would have to find a savings account paying 4.64%, while higher-rate taxpayers would have to find a savings account paying a whopping 6.18%.

Fail to do this and you may as well splurge all your savings today, because the value of your money is deteriorating as it sits in the bank.

And don't think you can turn to Cash ISAs for comfort. The market-leading Cash ISA from Santander pays just 2.75%. So even though the return is tax-free, you're still earning almost 1% below inflation. Ouch!

But don't despair. The situation may look bleak, but if you're clever, there is a solution. In fact, there are two.

Solution number one: NS&I Savings Certificates

I'm such a big fan of these certificates, I recommended them to my father. And I'm even more cautious with his money than I am with my own.

The reason I like them is because they are guaranteed to beat inflation. And, because they're tax-free (even if you've used up your ISA allowance). And, because they're backed by HM Treasury, so they're 100% safe (even if you want to invest more than the £50,000 compensation limits). OK, yeah, that's three reasons. They really are that good.

Here's how they work:

• The rate you earn is linked to the Retail Prices Index (RPI), which is one of the key measures of inflation and currently stands at 3.7%. As this index rises and falls, so does your rate.
• Lock your money up for three to five years, and depending on which certificate you go for, you can earn 1% above the RPI, every year, tax-free. That's the equivalent of earning 7.83% AER for higher-rate taxpayers, and 5.87% AER for basic-rate taxpayers, on a high street savings account.
• Even though NS&I only offer three and five year certificates, you can withdraw your money after a year to two years, and you'll still earn between 0.75% and 0.95% above the Retail Prices Index, per year, tax-free. Check out the details on the NS&I interest rates page. 

Solution number two: Use a current account

If you enjoy being a bit clever and beating the banks at their own game, you can take advantage of the high rates on offer to new current account customers to earn up to 6% on your easy access savings. For basic-rate taxpayers, that's an inflation-beating rate, and although the rate falls 0.18% short of beating inflation for higher-rate taxpayers, your money is instantly accessible without any penalties.

The trouble is, these current accounts have also sorts of sneaky catches in the small print - you can get around them, but you need to be aware of what they are. Read Earn 6% on your easy access savings to find out how to play the banks at their own game - and win.

• Compare savings accounts at lovemoney.com
• Adopt our goal: Build up your savings
• Ask a question on Q&A about savings accounts or inflation