Money: Still time to let a Tessa tempt you

The Tories' tax-exempt savings vehicle is near the end of the road.
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The Independent Culture
TESSAS, OR tax-exempt special savings accounts, will vanish from the market in less than three months. The savings account, brought in by the Conservatives in 1991, is due to be replaced on 6 April by Labour's new tax-exempt savings vehicle - the Individual Savings Account (ISA).

ISAs, like Tessas, allow you to reap tax-free interest on cash savings. They also place an annual limit on the amount of new money you can invest, but the limit for the cash element of an ISA - an ISA can also be used to hold shares and insurance - is lower than the Tessa limit. Savers can put up to pounds 9,000 in a Tessa over its five-year term, while for the first year only after launch the ISA cash limit will be pounds 3,000. After that an ISA only allows pounds 1,000 a year to be invested in cash.

It means not only can you save more tax free with a Tessa, but anyone opening one of the accounts before April will be able to take advantage of the overlap between the two systems by gaining both Tessa and ISA annual allowances.

"And when the Tessa does mature in five years' time, you can reinvest the capital in an ISA, and that won't affect your ISA allowance," says Philippa Gee, of the Shrewsbury-based independent financial advisers Gee & Company.

So if you want a cash investment, it is still worth taking out a Tessa, advisers say.

"Particularly at the moment when the outlook for shares over the next 12 to 18 months is a little uncertain," advises Ms Gee.

When the Tessa matures, the capital but not the interest can be rolled over into a Tessa-only ISA. This will be a separate cash investment, which will run alongside a cash mini-ISA or the cash element of a maxi-ISA.

The annual savings allowance may be higher, but Tessas are less flexible than their replacements. Once invested, the capital in a Tessa cannot be withdrawn until the five-year term is up. If it is, all of the interest for the full term becomes taxable. ISAs, on the other hand, can be instant- access accounts.

Most Tessas earn variable interest, which will probably fall over the next five years as the Bank of England cuts interest rates. But a few providers offer fixed-rate Tessas.

"This is certainly worth doing since we are in an environment of continually falling interest rates," says Philippa Gee. She recommends Abbey National's fixed-rate Tessa, which pays 5.5 per cent throughout the term.

There can be penalties for switching from one Tessa provider to another during the term. Some providers charge a fee, while others withhold up to six months' interest. Being effectively locked into a Tessa over the next five years could be quite a problem.

After April, Tessas will not be offered to new customers, making the accounts obsolete. Institutions have been known to let interest rates become uncompetitive on obsolete accounts, preferring instead to boost rates on those accounts which are actively marketed to the public. Providers deny that this will happen with Tessas.

"People will want to compete for roll-over Tessas as and when they mature," says Piers White, retail banking director of Fleming Premier Banking. "There will be strong competition to acquire those funds for Tessa-only ISAs."

However, it is still worth choosing one, where any penalty for switching is slight. Birmingham Midshires Tessa pays 6.85 per cent interest, but the penalty for transferring mid-term is the loss of 180 days' interest. This could be as much as pounds 190 half-way through the term.

Alliance & Leicester pays slightly less interest, 6.65 per cent, but the transfer penalty is more lenient, at 60 days' loss of interest. Ipswich Building Society requires only seven days' notice to transfer funds from one of its Tessas. "So clearly we'll have to keep rates competitive," says Paul Winter, who is the sales and marketing director at Ipswich.

Opting for a fixed-rate Tessa would give some security against rates becoming uncompetitive, says Philippa Gee.

When choosing a variable-rate Tessa, advisers warn against simply picking the institution at the top of the best-buy table. Piers White says that some providers are paying Tessa rates significantly above bank base rates, which means they are making a loss that they will be unable to maintain. He recommends opting for a provider with a record of paying good rates across all savings products.

Tessas are worthwhile only if they are held by taxpayers, since non-taxpayers do not have to pay tax on their savings. But Ms Gee says that couples sometimes seem to forget this, and it is the non-taxpayer who holds the Tessa.

"It is great that people have become educated to put investments into the non-taxpayer's name, but not in the case of Tessas," she says.

Gee & Company: 01743 236982; Abbey National: 01908 344978; Ipswich Building Society: 01473 211021; Fleming Premier Banking: 0800 092 3300