Focus on: Beat inflation with a 2.80% cash ISA

With no sign of inflation slowing anytime soon, savers need to do all they can to ensure their cash keeps pace with steep living costs.

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With inflation currently at 2.70%, as measured by the Consumer Prices Index, basic rate tax payers need a savings account paying at least 3.39% to gain benefit in real terms from their savings, increasing to 4.51% for higher rate tax payers, and 5.41% for additional rate taxpayers.

No easy access accounts and only a handful of cash ISAs, which offer tax-free returns, currently beat inflation. However, if you want to be certain that returns won’t fall, there is only one fixed rate ISA which enables you to lock into inflation-beating returns.

This is BM Savings’ three-year fixed rate individual savings account (ISA) which pays a competitive 2.80% annual interest tax-free – although you need a hefty £50,000 to qualify for this rate.

Here, we look at whether this could be the right account for you, as well as what the options are for savers who don’t have such large sums to invest….

What’s the deal?

BM Savings three-year Fixed Rate ISApays tiered rates of interest depending on how much you save. The account can be opened with a minimum investment of £500, with balances of this size up to £5,000 earning 2.20% annual interest tax-free.

Those with balances between £5,000 up to £10,000 earn 2.30%, rising to 2.40% for balances between £10,000 up to £25,000. Savers who have between £25,000 up to £50,000 earn 2.60%, while those with £50,000 or more earn the top rate of 2.80%.

The maximum you can invest into a cash ISA this tax year (2012/13) is £5,640, so to get the £50,000 rate of 2.80% you would have to also make transfers from existing providers. The account may therefore suit those looking to hold their ISA savings with the same provider.

Remember that if you are planning on investing a large lump sum, only the first £85,000 is protected under the Financial Services Compensation Scheme (FSCS).

You can make withdrawals from this account if you need to, but there is a penalty every time you take out cash. For example, if you make a withdrawal in the first year, you will lose 270 days’ interest on the amount withdrawn, while if you take money out in the second year, you lose 180 days’ interest. Withdrawals made in the final year of the fixed rate team will incur a penalty equivalent to 90 days’ interest on the amount withdrawn.

Any catches?

The biggest catch with the BM Savings three-year Fixed Rate ISA is that you only qualify for the top 2.80% rate of interest if you have a massive £50,000 savings pot.

However, one alternative for savers with smaller sums to invest is Halifax’s three-year fixed rate ISA. This account pays a marginally lower rate of 2.60% tax-free but the minimum investment is only £500.

Another benefit is that this account qualifies for the Halifax Savers Prize Draw where each month savers can win one of three top prizes of £100,000. Savers also have the assurance that if they are switching an existing cash ISA to Halifax, the bank will pay interest from day one of receiving the completed transfer application.

Savers signing up to either the BM Savings Fixed Rate ISA or the Halifax Fixed Rate ISA must be absolutely certain that they can afford to tie their money up for three years, as these accounts aren’t for anyone who thinks they might need regular access to their savings.

Another drawback of the BM Savings ISA is it can only be operated by post, so it won’t suit savers who prefer online or branch access to their savings. The Halifax Fixed Rate ISA, however, can be operated in branches or by telephone or online.

What’s the verdict?

The BM Savings three-year Fixed Rate ISA is the only fixed rate tax-free account which currently beats inflation, so is a great choice for anyone with significant savings. However, there are still options, such as the Halifax Fixed Rate ISA if you don’t have £50,000 to put away.

Whichever savings account you choose, always keep an eye on how much interest you're earning, so that you can be certain the purchasing power of your money isn’t being eroded by inflation.

Kevin Mountford, head of banking, at MoneySupermarket said: “With inflation remaining high, and set to remain so for the foreseeable future, people need to be prepared to limit the impact of the rising cost of living on their household budgets. For savers it is important to make sure you money is working as hard for you as it can do.”

Top tip!

If you don’t want to tie up your money in a fixed rate ISA for three years, then there are six easy access ISAs which beat inflation.

These include Newcastle Building Society’s Big Home Saver ISA, which pays 3.02% tax-free on a minimum deposit of £1, and is designed specifically for those saving to buy a home, and First Direct’s cash ISA, which pays 3.00% tax-free, again on a minimum investment of £1.

However, you have to have a 1st current account with First Direct to apply. Similarly, HSBC’s cash e-ISA, which pays 2.75% on tax-free on balances of £1 and above, requires you to have a HSBC current account to qualify.

You can compare all ISA deals at our ISA channel and learn more about these tax-free savings accounts with Esther Shaw’s article Every ISA question answered.

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

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