Where can savers find a home for their cash?

You can be forgiven for forgetting about the savings habit this year. Savings rates slumped as the bank base rate was slashed, leaving millions of people earning next to nothing on their hard-earned cash. But there's been some major movement in the savings market in recent weeks meaning it's now possible to get interest rates of nearer 4 per cent.

Lloyds TSB, for instance, this week increased the rate on its Monthly Saver account to 5 per cent. Colin Walsh, managing director of savings and investment at Lloyds TSB says: "Given the uncertainty around us, getting into a savings habit has never been more important. This is why we want to make it as easy as possible for our customers to build a nest egg and provide the added incentive of a competitive rate."

Lloyds isn't alone in tweaking or improving its savings offerings. For the first time in months, better deals and rates are appearing. So if you're not looking out now to find a better home for your savings, you're losing out.

"With interest rates at a historic low, it's more important than ever to ensure you're getting the best returns possible on your savings," says Kevin Mountford, head of banking at moneysupermarket.com. "If you have the means, it's well worth having a portfolio of different types of savings accounts. The average instant access account is paying just 0.15 per cent according to the Bank of England's latest figures, but you can earn more than 4 per cent if you have money you can afford to lock away." The idea of having different types of savings accounts may seem like too much hard work, but it makes perfect sense. To understand why, you need to consider why you are saving.

There are many reasons to save, not least to give yourself a nest-egg or some rainy-day money. This is cash that you can call on if you need it; self-protection if you like. Sensible folk should keep around three months' money locked away as a safety net in case of losing your job or even escape money, to give you an out from an unpleasant relationship, for instance. If you haven't got that sort of sum squirreled away then that should be a priority. It's emergency money which means you need to keep it in an instant access account. But more of those later.

Next you should have your saving-for-a-purpose money. This could be money you're building up to pay for a holiday, a car, even a home. You won't need the money in a hurry so you can look to lock it away for better rates. A regular savings account could be perfect and then, once you've built up a lump sum, it could be switched to a fixed rate bond. The key to maximising returns on savings when most accounts offer minimal interest rates is to fit the account to the strategy. Don't be tempted by high interest rates to lock cash away you may need in a hurry. On the other hand, don't accept paltry returns on savings that could be earning much more in some kind of notice account.

"The idea is to build a portfolio of savings products that cover all the bases, so regular savings to salt money away every month or to save for something specific, ISAs for tax-free interest, instant access for your emergency cash and a fixed rate bond for a higher rate," suggests Andrew Hagger of Moneynet.co.uk.

The savings habit is simply that – a habit. But it's a habit that's easy to form, says Hagger. "Everyone has to start somewhere, and by putting something away each month you'll soon build up enough to be able to take advantage of other potentially more rewarding savings alternatives. If you set up a standing order to your savings account that goes out on the day after you get paid, after a while you won't miss the money, neither will you be tempted to fritter it away."

If you don't think you can afford to save, think again. You can't afford not to. It may mean cutting back on luxuries – like expensive coffees – but, in the long term, stashing cash away will benefit you more than a daily caffeine boost. The key is to find the right account for your different savings needs.

Check out our best buy tables on page 60 for a selection of the top savings accounts. But don't be tempted to simply stick your money in the best-paying account; it really is crucial to first choose the type of account you need, then look at interest rates. Even then, you need to be wary of the small print and ensure that account restrictions won't mean you risk losing out on the higher rates.

"Be on your guard if you see a savings rate advertised that looks too good to be true as you may find that you'll have to comply with a number of restrictive terms and conditions and may even have to switch your current account to qualify," says Hagger.

His warning is echoed by David Black, principal consultant for banking at Defaqto. "Savers need to keep their wits about them as many savings accounts now have restrictions," he warns. "There is little point in being seduced by a high headline rate if your account usage is likely to preclude you from achieving that rate."

Defaqto's research reveals that a fifth of instant and easy access accounts limit the number of withdrawals allowed. The number climbs to a quarter of the 100 instant and easy access savings accounts that pay the highest interest rates on a £1,000 balance, says Black. Of those accounts, 38 per cent of them have an introductory bonus, 11 per cent have an introductory bonus and limit the number of withdrawals, and 51 per cent have introductory bonuses and/or a limit on the number of withdrawals.

Finding your way through the confusion means identifying the drawbacks. "For instance, regular savings accounts are worth considering as the leading deals are paying between 6 per cent and 7 per cent," points out Kevin Mountford of moneysupermarket.com. "But regular savers tend to have the most onerous terms and conditions so make sure you read the small print and don't just focus on the rate."

He also advises taking a close look at the length of fixed rates. "You need to be careful and not fix your savings for too long. The risk of locking your money away for longer than a couple of years is that you could find yourself stuck on a rate that becomes uncompetitive when the base rate starts rising again," says Mountford.

Also bear in mind tax. Interest on mainstream savings accounts is taxed at your normal income tax rate. But you can avoid handing the money over to the government by sticking money in an Individual Savings Account. The ISA is a government-backed scheme aimed to encourage saving. You can put up to £3,600 into a cash ISA in current financial year, and all gains are tax-free. The allowances are climbing from next April to £5,100 in a cash ISA, although the over-50s can use the higher limits from October 2009. In fact if anyone aged over 50 is saving regularly into a cash ISA, they can happily save £425 a month now into their ISA. Twelve monthly amounts will tot up to £5,100 in a year, but you won't bust the existing £3,600 limit before October.

Where should you save? Gemma Stanbury, head of savings at Confused.com, suggests Barclays for your ISA. "At the moment you can earn 3.61 per cent tax free with Barclays, which includes a 1 per cent bonus for 12 months. That's the equivalent of 4.51 per cent gross on a taxable account for a basic rate tax payer."

"Fixed rate bonds are offering great value at the moment compared to variable rate savings accounts, so it could be a good idea if you can afford to lock some of your money away for a year or two," says Stanbury. "ICICI bank is offering 4 per cent for 1 year and 4.35 per cent for 2 years on a minimum of £1,000. Interest rates aren't expected to climb that high over the next couple of years, however things can change and therefore the risk is that interest rates and inflation rise sharply over the term of the bond – but at least you know how much interest you are going to earn."

Invest £10,000 in the ICICI account over two years and you'd earn £840 more in gross interest than if you left the money languishing in an account paying the current average rate of 0.15 per cent. However, as rates are likely to rise, the returns on that locked-away cash will begin to look less attractive. It means locking your money away for anthing longer than two years, could prove a costly mistake. "Savers shouldn't be swayed by an additional 0.1 per cent or 0.2 per cent to lock their money away for four or five years as they risk losing out when rates recover," warns Moneynet's Andrew Hagger. "The shorter term strategy certainly makes more sense in the current environment."

Saving on the net

Money lending website Zopa can be an attractive alternative for your savings, suggests Ed Bowsher, head of consumer finance at LoveMoney.com.

"It's like an eBay for the savings market," he explains. "You transfer money into your Zopa account – you can start saving with just £10 – and Zopa then lends it to a group of borrowers."

The site has been operating for two years and so far only 0.27 per cent of all loans have become bad debt so far. That's because Zopa uses the same credit checks as the banks, so you're almost certainly going to get your money back, says Bowsher.

"The rates on offer change all the time, but they're normally pretty good. Even better, you cut the banks out of the process. Instead you're directly helping ordinary people who are looking for cash."

However, if you want to have your money available at your cashpoint, then a traditional account through a bank or building society may be your better bet.

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