Don't miss these inflation-busting savings accounts!

Inflation is the enemy of savers everywhere, particularly when savings rates are already exceptionally low. Inflation eats away at the real return on your cash, and ultimately reduces your spending power.

Why has inflation jumped up?

The latest figures show the government's preferred measure of inflation - the Consumer Prices Index or CPI - was 2.9% in December. That means the price of goods and services is 2.9% higher in December 2009 than it was in December 2008.

The increase in the CPI annual rate on the previous month was a whopping 1%. This is the largest ever increase from one month to the next, which gives us an idea just how rapidly inflation is growing.  

According to the Office for National Statistics (ONS), this increase was down to key events which took place in December 2008.

At this time the standard VAT rate was cut from 17.5% to 15%. On top of that, sharp reductions in oil prices, and huge retail discounts in the run up to Christmas to combat poor trading put considerable downward pressure on prices. These factors caused the CPI to drop 0.4% between November and December 2008 - the greatest fall between two consecutive months.

What does all this mean for savers?

To earn a real return on your savings, your interest rate must beat tax and inflation. The table below shows the minimum rate needed for savers in each tax bracket:

If you're a non taxpayer you're entitled to earn interest gross. You don't need to worry about tax (as long as you fill in an R85 form), but you do need to earn more than 2.9% on your savings to combat CPI inflation.

If you're a basic rate taxpayer, your minimum rate must combat a 20% tax deduction from the interest you earn, plus a 2.9% reduction for inflation. This means a gross rate of at least 3.63% is called for.

Finally, if you're a higher rate taxpayer, you'll suffer a 40% tax deduction from your interest. Your minimum gross rate needs to be 4.84% to beat tax and inflation.

Now let's take a look at whether any savings accounts can provide the returns we need:

Which accounts are suitable for non-taxpayers?

For everyday savings, there are several accounts which fit the bill by offering rates of more than 2.9%. Check them out in the table below:

The top two accounts from Coventry BS and Lloyds TSB come with some pretty awful withdrawal restrictions. With Coventry, you're only allowed four penalty-free withdrawals, and with Lloyds, 0% interest is paid in months when a withdrawal is made. If you prefer an account which offers true easy access and beats inflation, the Scottish Widows Bank Internet Saver is your best bet.

If easy access isn't your main priority, and you can afford to lock your money away, you could choose a short-term fixed rate bond instead. The best rate available today is the 18 month PBNIL NET Fixed account from Punjab National Bank which pays 4%.

Alternatively, ICICI Bank UK is paying 4.25% on its HiSave Fixed Rate account which lasts for two years.

Which accounts are suitable for basic rate taxpayers?

If you fall into this tax bracket, you won't be able to find an ordinary savings account which beats tax and inflation since you need a minimum gross return of 3.63%.

You could achieve this rate by choosing either of the bonds mentioned above. If you don't want to tie your cash up, you could go for a high interest current account instead.

For example, you can earn up to 6% with the Alliance & Leicester Premier Direct current account. This rate is fixed for a year, but bear in mind it only applies to the first £2,500 of your balance. Cash over this amount earns just 0.10%. And you'll need to fund the account with at least £500 a month. However, you can immediately withdraw this money, or set up a standing order for it to leave your account the day after it enters every month.

There's a similar deal available from Santander with the Preferred In-Credit Rate account, but this time you must pay in £1,000 per month.

Which accounts are suitable for higher rate taxpayers?

It's trickier still for higher rate taxpayers to keep ahead of tax and inflation with a minimum rate of 4.84% required.

High interest current accounts could provide a solution, but what if you have more to than £2,500 to save?

You could choose a longer-term fixed rate bond. Birmingham Midshires offers a 4 Year Fixed Rate Bond with a return of 5%, while Aldermore offers a five year Fixed Rate Account which pays 5.15%.

However, I don't think long-term bonds are a great choice for savers right now. If interest rates take off - as many expect - a 5% plus rate may not stay competitive throughout the term.

Alternatively, all savers - not just higher rate taxpayers - could get a better rate on their savings using Zopa. Zopa enables you to lend money to other people and get an attractive return where you set the rate yourself.

In the last year, Zopa lenders earned an inflation-busting average rate of 8% - after fees, but before bad debt and tax. Find out more in this video.

A choice for all savers

Finally, with inflation on the rise, it's a good idea to think about Index-Linked Savings Certificates from National Savings and Investments. Certificates currently pay a rate of RPI + 1% and they're tax-free. You can save between £100 and £15,000, but you'll need to tie your money up for three or five years.

The RPI - or Retail Prices Index - is an alternative measure of inflation which is currently 2.4%. So the tax-free return at the moment is 3.4%. This beats tax and inflation for all savers.  

If you have a question about where to put your hard-earned cash, why not ask the lovemoney.com community for help at Q&A. And make the most of your money by joining our Build up your savings goal.

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