Savings: why smaller banks are offering the best returns

Savers who want the best rates should turn to smaller banks, according to new research.

Lesser-known providers such as Al Rayan Bank, Bank of Cyprus UK and Ulster Bank are outdoing the bigger players when it comes to savings, with rates as high as 2.55%.

On the whole, interest rates have risen on instant access savings accounts as well as two-and-five-year fixed deals compared to a year ago.

Figures from financial data site Moneyfacts reveal that the best deals on easy access accounts have risen from 1.2% to 1.25% and the best five-year fix has jumped from 2.08% to 2.51% over this period.

But even though smaller banks offer better rates, none can match the current rate of inflation, which jumped from 2.6% to an unexpected 2.9% in August.

What's more, the Bank of England Base Rate has been held at 0.25% yet again, meaning that relatively poor savings rates are set to continue in the short-term at least.

So, where should you put your cash? Before we reveal the top deals, it's worth flagging up two key recent developments that should change the way you think about savings.

A new savings landscape

The first is the Personal Savings Allowance (PSA).

Launched in April 2016, the PSA allows basic rate taxpayers to earn up to £1,000 and higher rate taxpayers to earn up to £500 in savings interest tax-free. Additional rate taxpayers do not have a PSA.

This means instant access, notice and fixed-rate bonds are now far more lucrative as providers will stop taxing savings interest at source.

The second change is the dramatic rise of current accounts as a viable home for your savings.

While banks have traditionally offered terrible rates of interest on in-credit current account balances (and many still do!), some are luring new customers by offering rates that comfortably beat the best buy savings accounts.

And, as they're also included in the PSA, you get the same tax benefits to boot.

Let's look at all of these and more to see what rates you can get and where the best place to put your cash is.

Current accounts

As we've already mentioned, some current accounts offer inflation-beating rates. The downside is they have pretty miserly deposit limits, and increasingly require you to jump through a few hoops to qualify for the headline rate.

So let's take a look at the best.

Nationwide's FlexDirect account pays 5% interest on balances up to £2,500 for the first 12 months. The only condition is you need to pay in at least £1,000 a month.

TSB's Classic Plus account pays 3% on balances of up to £1,500, provided you credit the account with £500 a month.

The Tesco Bank Current Account also pays 3%, but this applies to balances of up to £3,000. To qualify, you'll need to pay in at least £750 a month and have at least three direct debits (not including Tesco Bank savings accounts).

Bank of Scotland's Classic Account with Vantage pays 2% on balances between £1 and £5,000 if you pay in £1,000 a month and have two direct debits set up.

Lloyds Bank is offering the Club Lloyds account, which pays 2% on balances between £1 and £5,000, as long as you credit the account with £1,500 a month and set up two direct debits from it.

If you don't want to spread your money around, Santander's 123 account pays 1.5% on balances of up to £20,000. You need to pay in £500 a month, and set up at least two direct debits.

There's also a £5 a month fee on the account but you can earn cashback on some of your direct debits for household bills, which can help cover that.

Now let's look at how traditional savings accounts fare. As we noted at the top, none of these can currently beat inflation, but they do allow you to deposit far larger sums than current accounts.

Instant access savings accounts

The top rate of interest on an easy access account is currently 1.25% which you can get from Ulster Bank. You only need £1 to open an account.

Notice accounts

If you give up access to your cash for 180 days you can get a rate of 1.65% from Secure Trust Bank, but you'll need a sizeable £1,000 to open it.

Cash ISAs

While the PSA has effectively made all savings accounts tax-free, you should still consider using your tax-free ISA allowance (currently £20,000 for 2017/18).

That's because any money you put into an ISA will stay tax-free long term, even if the interest you earn grows. With the PSA, any interest you earn beyond the £1,000/£500 limit is taxed at your marginal rate.

The best rate on an easy access ISA is available with Virgin Money. It's paying 1.06% on deposits from just £1.

Savers are normally only allowed to open one Cash ISA account per tax year, which means having to choose between the flexibility of an easy access deal and a better rate by locking into a fixed-rate deal.

If you don't mind waiting for a little while before withdrawing your cash, you can opt for a 120 Day notice account from Al Rayan Bank which has an expected profit rate of 1.21%. There's a minimum deposit of £250 to open the account.

You could also lock your money up for a year with Al Rayan Bank and you'll get a rate of 1.35%. You'll need a substantial £1,000 to open an account.

The best Cash ISA over two years is from Al Rayan as well, offering a rate of 1.70% on balances from £1,000.

Bank of Cyprus UK wins out over three years, offering 1.42%.

Virgin Money has stormed to the top of the five-year best buy tables, paying a rate of 2.15%. You'll need to put in at least £1.

Fixed-rate bonds

The Bank of London and the Middle East (BLME) is the best option for savers looking to lock their money away for one year, paying 2.00%, but it has a high minimum deposit of £25,000.

The best two-year rate of 2.22% on deposits starting at £1,000 from Al Rayan Bank. It dominates the three-year tables as well, with a rate of 2.32%. Again, you'll need a £1,000 deposit.

As for the five-year, look to Secure Trust Bank which gives you a rate of 2.51% with a minimum £1,000 deposit.

Bank of London and the Middle East (BLME) rules the roost for seven-year deals, with a 2.55% rate and a mighty minimum deposit of £25,000. It's a heck of a long time to lock your money away, but it beats the rest of the deals when it comes to the rate.

If you want to deposit a more reasonable sum of cash, you can plump for PCF Bank which has a 2.40% rate on its seven-year bond, but you'll need to put in at least £1,000.

Where to earn the most interest on your cash

Here's a table with all the top deals for you to compare at a glance.

The account you go for will probably be determined by the amount you have to save and whether you want instant access to your money.

*Anticipated profit rate

**Current account charges a £5 monthly fee

What's clear though is that if you want a better return on your money in the longer term, you're better off looking beyond traditional savings accounts right now.