How safe are your savings?

Savings accounts are safe, aren't they? Sadly the answer is: not always. If the interest rate you are earning after tax is deducted does not match the rate of inflation, the purchasing power of your savings will gradually reduce. A rising number of savers is now falling into this trap.

About a quarter (26 per cent) of savings accounts are failing to produce inflation-beating returns for basic-rate taxpayers, while for higher-rate taxpayers 58 per cent of accounts are lagging behind, according to Bates Investment Services. It found that nearly one in five savings providers, including Tesco Personal Finance, Smile and Cahoot, fail to offer a single account capable of providing positive real rates of return for higher-rate taxpayers.

The rate of inflation partly depends on which measure you use. Based on the retail price index (RPI) annual inflation is 2.8 per cent, while consumer price index (CPI) inflation - the government's preferred measure - is 2.4 per cent. CPI inflation has increased as a result of oil price rises and is at its highest level since it was introduced in January 1997.

'With Bank of England base rate on hold at 4.5 per cent and inflation rising, savers are increasingly under threat,' says Justin Modray of financial advisers Bestinvest.

For a positive 'real' return, savers must earn enough not only to beat inflation, but also to cover their tax bill. Bates Investment Services calculates basic-rate taxpayers need a gross interest rate of 2.88 per cent to match inflation, while higher-rate taxpayers would need 3.83 per cent.

However, this is based on RPIX inflation (currently 2.3 per cent), which excludes mortgage payments. If they are included, RPI inflation might be a better measure. Matching this is tougher. Basic-rate taxpayers need to earn 3.5 per cent gross on their savings and higher-rate taxpayers 4.67 per cent.

So how can savers protect themselves? Cash mini-Isas are a good solution for savings up to £3,000 because returns are tax-free, says Modray.

But the only way to a return guaranteed to be above inflation is index-linked government securities or National Savings index-linked certificates. Returns are equal to inflation as measured by the RPI, with a nominal additional return on top.

National Savings certificates (application forms are available in post offices) are the easier option. They run for three or five years and the current issues offer index-linking plus 0.95 or 1 per cent respectively. Up to £15,000 can be invested per issue. Returns are tax-free, so for higher-rate taxpayers the equivalent gross return based on current inflation would be more than 6 per cent. For basic-rate taxpayers, the return on a five-year certificate is equivalent to 4.75 per cent - which can be beaten by an ordinary savings account.

From small beginnings ...

Don't forget that your children's savings also need to be protected from inflation. Anyone aged seven or over can invest between £100 and £15,000 in three- or five-year Index-Linked National Savings Certificates. According to National Savings & Investments, an 18-year-old whose parents had put aside £2,000 every five years in these certificates would now have a sum of £15,935. This compares with £10,956 if it had been put in a typical high street savings account.