Savings: The best places to keep your money safe – and beat inflation

The rising costs of food, petrol and heating have pushed inflation up past 4 per cent over the last few weeks, and for some of us – most notably the elderly – the cost of living has been rising at a much faster rate. Although the pressures of rising inflation are being felt firstly in consumers' wallets, another unfortunate side-effect of rising prices is that your savings also need to work much harder to keep pace with the true cost of living.

Taking the Government's latest figure of 4.3 per cent for inflation (as measured by the Retail Prices Index), basic-rate taxpayers now need to earn at least 5.38 per cent on their savings to beat both tax and inflation. If you're a higher-rate taxpayer, the situation's worse – with nothing less than 7.17 per cent likely to be good enough to provide you with a real return after tax.

The good news is that while the Bank of England base rate is still at just 5 per cent, the credit crunch has pushed savings rates up – as banks fight to get their hands on your money. Last time inflation rose above the current levels – in December 2006 – the base rate was also at 5 per cent, but it was impossible to get savings accounts that paid much above that.

Today, it's possible to pick up one-year fixed-rate savings bonds paying more than 7 per cent, while there are regular savings accounts paying in excess of 10 per cent. Below, we take a look at the best accounts in each market.

Cash ISAs

Unless you're planning to use your full £7,200 ISA allowance for investing in stocks and shares, it's worth starting off any savings pot you have in a cash ISA, which is protected from tax. All UK taxpayers are allowed to put up to £3,600 a year into a cash ISA, and the best accounts currently on offer will pay you a rate of over 6 per cent.

For the best ISA rates, you'll need to agree to tie your money up for a year. For example, Julian Hodge Bank will pay you 6.5 per cent in its one-year fixed-rate ISA, while Halifax will pay you 6.3 per cent on a similar account.

The important thing to remember with cash ISAs is that even with rates as low as 5 per cent, you're still beating inflation as there's no tax to pay.

Instant Access

Once you've used up your ISA allowance, the next step is to find an account that pays as high a rate as possible, but which still gives you penalty-free access to your money.

Beware that many so-called "instant access" savings accounts will dock you interest during a month when you make a withdrawal, so be sure to read the small print. HSBC's online bonus saver, for example, pays 5.25 per cent, but only the equivalent of 2.5 per cent in any month where you make a withdrawal. According to research by Sainsbury's Finance, 12 of the top 50 savings accounts have restrictions on withdrawals.

It's also important to watch out for introductory savings rates – where banks pay a high rate for the first few months, only to revert to a much lower rate later. For example, Abbey currently offers one of the top five instant access accounts on the market, paying an impressive 6.5 per cent. However, savers only receive this rate for the first 12 months, after which the account will only pay 5.5 per cent. Furthermore, there is no guarantee about where the account's rate will go from there. This is still good value if you know that you'll have the discipline to shop around in a year.

Birmingham Midshires and Kaupting Edge currently offer the best instant access savings rates with no ties, paying 6.52 and 6.5 per cent respectively.

For higher-rate taxpayers, there isn't an instant access account on the market that pays enough interest to help you beat both tax and inflation. However, some regular savings accounts and fixed-rate bonds do pay more than the 7.17 per cent that you'll need to make a real return after tax.

Regular Saver

If you're looking to put away between £10 and £500 each month, you can earn rates of up to 12 per cent interest. However, you'll also need to be prepared to move your current account to get these kind of deals.

Alliance & Leicester pays 12 per cent on its Premier Regular Saver, on amounts of up to £250 a month. But only for the first year, and only if you switch to it from another bank. Alternatively, Halifax will pay you 10 per cent on its regular saver account – even if you don't have your current account with them – on deposits of up to £500 a month, but again only for one year. You can't make any withdrawals from either of these accounts during the first year.

These accounts can prove good value, but they tend to be subject to more stringent conditions and limits than most, so think carefully about whether they really make sense for you.

Fixed rate

The best rates are always reserved for those who are willing to tie up their money up for at least a year, without making any withdrawals. At the moment, Abbey will pay you 9.1 per cent if you're willing to tie your money up for a year, but only if you invest the same amount in one of their investment products, as you out in the savings bond.

Birmingham Midshires' Internet one-year fixed-rate bond will pay you the magic 7.17 per cent which higher-rate taxpayers need to beat tax and inflation, while Bank of Cyprus has a couple of one-year bonds paying 7.15 per cent. The best two-year bonds pay around 7.12 per cent, such as West Bromwich Building Society's E-Bond 14, while FirstSave offers a three-year bond for 7.1 per cent.

Again, it's important to read the small print when it comes to fixed-rate savings bonds. Some will allow you to get your hands on your money before the policy matures and others won't. Of the ones that do let you cash in your policy early, some will take away all the interest you've earned, while others will take only some of it.

Where to find the best rates

Websites such as moneyfacts.co.uk, defaqto.com and moneysupermarket.com are among the best for hunting down the best savings rates. Each of these break down accounts into relevant different categories, and provide information on relevant restrictions and limits. Alternatively, to find an independent financial adviser in your local area, visit www.unbiased.co.uk.

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How safe are your savings?

Since last autumn, the first £35,000 of any money held on deposit in a UK savings or current account is protected if your bank or building society goes bust. However, you may have to wait for months before you get it back. While you're probably keeping your savings in cash so that you can get your hands on them at any time, the current protection system – the Financial Services Compensation Scheme (FSCS) – admits that, were a bank to go bust tomorrow, it could take as long as a year to refund consumers.

This week, the Government unveiled new proposals to increase the guarantee to cover the first £50,000 of savings and bank deposits. The Government will also loan the FSCS the money it needs to make payouts to consumers "within days" of a bank failing. However, these proposals are not scheduled to come into force until this autumn.

In the meantime, anyone who can't afford to be left without access to their savings for a year should think hard about who they bank with. Ironically, the only bank with a 100 per cent, cast-iron unlimited guarantee is Northern Rock. Having been nationalised earlier this year, savers can be confident that their money is safe. Plus, they have a number of quite good rates on offer. Its instant access e-saver account, for example, pays 6 per cent, up to a maximum of £250,000.

The other place where your money is safe is with National Savings & Investments, which is also owned by the Government. However, their rates are disappointing when compared to their sister bank Northern Rock. In fact, none of their non-ISA savings accounts will even beat inflation and tax.

The next best option is to stick with the big players. The likes of Abbey and HSBC have barely flinched during the credit crunch. Abbey currently offers an instant access savings account paying 6.5 per cent for the first year, and 5.5 per cent thereafter. While HSBC offers 6.25 per cent on its cash ISA.

Finally, you might want to consider a building society – such as the likes of Nationwide, Britannia, or one of the many small local societies. Although building societies are by no means immune from the credit crunch, the fact that they are owned by their customers rather than shareholders give them a valuable weapon in tough times like these.

This mutual structure allows them to sacrifice profits to ensure their customers get paid and they always have the option of raising money by demutualising if things get really bad. Nationwide's instant access accounts are currently not that competitive. However, the society is offering one-year fixed-rate savings bonds paying 7 per cent.

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