If you haven't checked the interest rate on your savings account recently you are almost certainly losing money. Banks and building societies have been cutting interest rates on savings as much and as often as they can. So most savers are losing their purchasing their power as their savings fail to grow in line with inflation.
The most recent numbers showed inflation as measured by the consumer price index (CPI) running at 3.5%. But the average rate paid on an instant-access account is just 0.86%. So even before you take tax into account, you're losing more than 2.5% a year in real terms (ie after taking inflation into account).
Even more shocking are the rates on notice accounts. Usually these are higher than the rates on instant access accounts. You get extra interest as a reward for locking your money away for three or six months. Not so this year. 40 notice accounts are paying less than 0.5%. The Halifax's Extra Income Saver account is paying a mere 0.13% on up to £10,000 at 60-days notice, according to the FT. It's a classic example of a financial product doing precisely the opposite of what it claims to do.
So what can you do to make sure that your money grows rather than shrinks every year? You need to find an account that pays enough interest to beat inflation, even after you've paid tax on your interest. So a basic-rate taxpayer needs a gross interest rate of 4.38%, while a higher rate taxpayer needs their money to be earning 5.83%. If you opt for an Isa then you only need a rate of 3.5% or above, as your money won't be taxed.
Are Isas the answer?
Surely then, an Isa is the option to go for? Well, you should definitely always use your Isa allowance. Any legal opportunity to dodge tax should be grasped with both hands. But this year there aren't any Isa interest rates that really impress.
The best short-term fixed rates are 3.5%. So you'd have to lock up your money for at least three years to beat inflation – Skipton Building Society pay 3.75% on their three-year fixed-rate Isa. But once that money is in an Isa it is protected from tax for life unless you withdraw it. So even though Isa interest rates are pretty rubbish this year it's still worth using your allowance.
Make the most of current accounts
The only bank accounts offering really good rates of return just now are current accounts. Alliance & Leicester's Premier Direct Current Account pays 5% interest on balances up to £2,500, as does its parent company Santander. Meanwhile Halifax pays £5 a month to holders of its Ultimate Reward Current Account.
To get these rates you need to pay a regular sum into the accounts - £1,000 with Santander and Halifax, and £500 with Alliance & Leicester. And you can't earn 5% on both a Santander and an Alliance & Leicester account. If you have both accounts in your name one will earn 5%, and the other 1%. But you could get round this by putting one account in your spouse's name.
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The easiest way to make sure you meet the funding requirements of the accounts is to set up a direct debit moving money between them. So have £1,000 automatically transferred from Santander to Halifax at the same time as you have £1,000 transferred from Halifax to Santander. The banks have confirmed that the regular income doesn't have to come from an employer, so this arrangement is acceptable, reports Ali Hussain in The Sunday Times.
So if you have a £3,500 lump sum and you place £2,500 in the Santander account and £1,000 in the Halifax account (and make sure you set up the regular transfers between the two) then you would earn £185 gross a year. Whereas if you had placed the money in the best one-year bond – the Post Office pays 3.3% - then you would have earned £116 gross. The difference might not sound like much, but it comes with very little effort.
What to do with larger amounts
If you have a large sum that you want to save in a low-risk account then the best account that I can find is Investec's High 5 Account. This account's interest rate is re-calculated each week, as it pays the average of the five highest paying savings accounts published in the best-buy tables of the Moneyfacts website. It is currently paying 3.16%.
The catch is that the minimum deposit is £25,000. You also have to give three months' notice to withdraw your cash. But it's worth it for the peace of mind of knowing your money is always getting a good rate.
To keep your risk to a minimum, only invest a maximum of £50,000 in the account so that you are completely covered by the Financial Services Compensation Scheme (FSCS). If you need a home for more than £50,000 then put the first £50,000 in the Investec High 5 Account, then work your way down the best buy tables in £50,000 chunks. Just make sure that the bank or building society is covered by the FSCS. So if the bank is foreign double-check its guarantee system. Also make sure that you don't invest with two companies that share a banking licence, as then you would only be covered for the first £50,000. You can check which banks share licences here.
Offset your mortgage
If you have a large amount of savings and a mortgage, it may be worth getting an offset mortgage. With an offset, any savings you have are placed in a savings account which is linked to your mortgage. The savings don't earn any interest. But the balance of your savings account is deducted from your home loan.
So if you have a £200,000 mortgage and £25,000 in an offset account, then your mortgage interest payments would be worked out on the basis that the mortgage was only £175,000. If you took out the First Direct offset lifetime tracker at 3.59%, that would save you £897.50 in interest a year.
So don't despair. Savings rates may be low. But there are ways to improve the return you are getting.
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