Inflation is at a 19-year high meaning virtually every savings account would fail to keep pace with the cost of living were prices to continue rising at this rate.

In fact, no standard deal can match the current 5.3% Retail Prices Index (RPI) measure, which has not been higher since 1991.

Even where you see a rate close to that, remember any interest is usually taxed (unless in a cash Isa) so the real returns are even lower (see the Top Savings guide).

The only mainstream savings account that guarantees to beat future inflation comes from National Savings & Investments (NS&I), the government-run bank, though it's not the best deal for everyone.

It will beat RPI by one percentage point if you keep the money in there for either three or five years. And unlike most non-Isa savings accounts, the returns are tax-free.

This Q&A guide explains how inflation impacts your savings and how to beat it.

What is inflation?

It is the measure of the rise (or fall, in which case we have deflation) in the cost of living.

Every month, the Office for National Statistics publishes annual inflation figures, based on a basket of everyday goods we all buy.

This tracks the extent to which the cost of that basket has risen (or fallen) over the past year.

How does inflation impact savings?

The idea of saving money is to keep it for a rainy day or a special purchase, but also to make that cash grow by as much as possible

What you don't want to happen is for your cash to lose value. While it may grow even on a 0.01% interest rate, if prices rise by 5.3% in the coming year, your cash will buy you a lot less in 12 months than it does now.

Imagine you've £1,000 in the top 2.8% instant access savings account, after (basic rate) tax you'd have £1,022.40 after a year – as you've earned £22.40 interest. Yet suppose that £1,000 is enough for ten weekly supermarket trips.

If prices rise by 5.3% next year, you'd need £1,053 to buy the same goods.

So although your savings might have grown, the impact of inflation means what you can buy has actually decreased.

When comparing savings rates to inflation remember that inflation figures measure how prices have fared in the past year, though you'll want to ensure your cash keeps pace with inflation in the coming year.

What is the RPI index?

Inflation is measured by two indices: the Retail Prices Index (RPI) and the Consumer Prices Index (CPI).

While CPI is the official measure used by the Government, it does not include housing costs in its basket, whereas RPI does.

How does the NS&I account work?

NS&I's index-linked savings, where you can save between £100 and £15,000, guarantees to beat the annual RPI inflation measure by one percentage point, tax-free, if you keep the cash there for the full term of the account (either three or five years).

However, it is not that simple. If you take the three-year account, you're paid the annual RPI rise + 0.85% in year one, RPI + 0.95% in year two and RPI + 1.21% in year three. That makes RPI + 1% overall.

If you take the five-year account it's + 0.75% in year one, then 0.85%, 0.9%, 1.15% and 1.36%. Again, that totals RPI + 1% overall.

If you withdraw your money in year one you earn no interest. In further years, you'll get the interest earned up to the month you withdraw the cash so you lose no interest.

However, you'll get less than the advertised RPI + 1% given the stepped nature of the way interest is paid.

How is the exact amount calculated?

You are paid the headline annual RPI figure two months before the anniversary of your account opening, plus the bonus rate. Yes, we know it's complicated, too!

That means today's annual inflation figure is irrelevant.

Here is what would happen on the three-year account:

  • Step 1. If you open an account today, in May 2010, the first anniversary month would be May 2011, but it's the actually the March 2011 RPI figure, which we'll only discover in April 2011, which would be used.
  • Step 2. If March 2011's annual RPI inflation figure is 5%, you're paid 5% interest plus the 0.85 percentage point bonus in year one, to make a 5.85% rate. If you had a £1,000 balance, you'd get £58.50 interest to create a new £1,058.50 balance.
  • Step 3. That balance is brought forward to calculate your second-year earnings. If RPI was 5% again a year later, you'd get 5.95% interest (as the bonus is higher in year two at 0.95%) of £62.98, to create a new balance of £1,121.48.
  • Step 4. That balance is brought forward to calculate your third-year earnings. If RPI was 5% again a year later you'd get 6.21% interest of £69.64, giving you a final balance of £1,191.12.

That means you'd have turned £1,000 into £1,191.12.

You apply the same logic for the five-year account.

What if we get deflation?

If the cost of living falls in any year, the value of your savings will not drop. Inflation will be deemed to be 0% in such cases, and you'll still get the relevant bonus.

Why is there confusion over the rates paid?

There has been some confusion around what this account pays, mainly distributed by Post Office employees who sell this product, according to emails we have received from staff and customers.

Some consumers are being told the account pays the difference between today's annual RPI inflation figure (5.3%), and whatever it is in a year, plus the bonus.

So, if the annual RPI measurement stands at 6.3% in 12 months, and given the bonus in year one is 0.85%, that suggests you'll earn 1.85% on your cash tax-free.

NS&I has confirmed this is not true. The bank insists the problem with mis-information is not widespread but says it will investigate evidence we've provided to ensure all Post Office branches are giving the correct advice.

Is the NS&I account the best one to have?

While it guarantees to beat inflation, that doesn't mean it will pay the best rates throughout the term.

That all depends on future inflation, the Bank of England base rate and how banks and building societies price their products in months and years to come.

Further reading/Key links

Best rates: Top Savings, Top Fixed Savings
Stay safe: Safe Savings