Tax-free savings: the sequel

After five years tied up in the first generation of Tessas, investors are free to move their money into a new scheme. Clifford German looks at what's on offer

After five years of virtual inactivity the pounds 28bn Tessa market burst into life late last year like a sleeping giant, and has not stopped since. Two million investors -many of them with the maximum permitted pounds 9,000 of capital plus accumulated tax-free interest -suddenly found themselves courted by banks and building societies trying to persuade them to take out new Tessas with the same supplier.

More than half the cash locked up in Tessas since 1991 was actually invested in the first few months of 1991 when interest rates on variable rate accounts were running at up to 15 per cent, and a tax-free Tessa was seen by traditional investors in bank and building society accounts as a heaven-sent opportunity to shelter interest on long-term savings from tax.

In fact interest rates almost immediately starting falling and had halved by the end of last year, and once the initial rush had been satisfied demand for new Tessas tailed off very quickly.

Suppliers were free to set their own rates without even a link to base rates, and investors had to accept whatever rates their suppliers chose to offer them, or lose their tax-free status, and sometimes suffer some loss of interest penalties as well. But most investors settled down to wait for 1996.

As the first generation of Tessas approached maturity however, tables of comparative performance started to appear and it became clear that the best Tessas - almost all provided by small banks like the Julian Hodge Bank in South Wales, and small building societies like the West Bromwich and the Cheshire, - would have added up to pounds 3,200 worth of interest.

These figures were comfortably more than most of the big building societies had paid, and almost pounds 1,000 more than the worst performers (who included the big four London clearing banks plus the Clydesdale Bank and the Bank of Scotland) had achieved.

The stage was set for a struggle to attract the maturing accounts. Under Treasury rules all maturing Tessa accounts have to be closed and the capital withdrawn or switched into a conventional taxable account, and the tax- free interest also has to be redeployed.

But investors are free to roll over the capital into a second generation Tessa or transfer it without penalty to a Tessa with a different supplier. They can also keep the capital for up to six months in a separate account before they have to choose their new Tessa, provided they have obtained a maturity certificate.

With so much money at stake banks and building societies started offering special rates, both floating and fixed, in an attempt to retain maturing accounts and win new customers. The picture has however been complicated by the fact that interest rates instead of starting to rise have continued to fall, making some of the initial fixed-rate offers look increasingly attractive.

Some suppliers, like the TSB, allowed holders of maturing Tessas to book rollover Tessas in advance. But within days of the opening dates both the TSB and Northern Rock, two of the most attractive offers, were oversubscribed and replaced by less attractive offers, leaving some account- holders with maturing accounts who thought they had plenty of time to pick and choose seething with disappointment.

The battle for business has, however, created a plethora of offers for investors to choose from. Almost 100 different banks, building societies and other financial institutions provide Tessas, and most of them are now simultaneously offering a First Tessa which is available to virgin investors who were too young or too poor to take out a Tessa in the first round, and Second Tessas available only to investors who have a maturing Tessa to reinvest.

Most first-time Tessas offer variable rates of interest only. Just a handful have been offering fixed rates. Most of the follow-on or rollover accounts offer a choice of a variable rate, which can rise or fall at any time at the discretion of the provider, or a fixed rate for the full five years. A handful of accounts are offering escalator rates -rising each year to a peak in the fifth year - while others offer loyalty bonuses payable at maturity.

A small number of providers are offering guaranteed returns over the full five years, expressed either as a compound interest rate or CAR, or as a running total after five years, and some even provide a link to the UK stock market.

Most providers offer regular savings plans. Some have a high minimum deposit, others will take as little as pounds 1. Many offer tiered interest rates, paying progressively higher interest rates the larger the size of the deposit.

Abbey National has caught the mood with the advertising campaign behind its three Tessas: a variable rate open to all, a fixed rate at 7 per cent a year, only for roll-overs, and another guaranteeing a 41 per cent return after five years.

But Abbey National is positively simple compared with some other providers. Birmingham Midshires, for example, has eight Tessas on the go, starting with a Quantum Tessa, for complete beginners, which pays a variable interest rate, currently 6.5 per cent, on as little as pounds 100.

For anyone with a minimum of pounds 1,000 to invest from scratch, or to reinvest from a maturing Tessa, there is a fixed-rate Tessa, an Escalator Tessa which builds up from 6.25 per cent in the first year to 9 per cent in the fifth and final year, and a variable rate.

There is also a rather provocatively named Election-Beater Tessa, which offers a fixed 6.75 per cent until the end of 1997, shifting to a variable rate thereafter (politicians can make what they like of the implications of that), and an Inflation-Beater Tessa which offers a variable rate of at least 3 per cent above the going rate of inflation.

If that is not enough to be going on with, the same society also offers investors with a full pounds 9,000 in their maturing Tessa account a choice to reinvest in an equity-linked Tessa, which guarantees a minimum return of 20 per cent over the full five years, even if the FT-SE 100 share index falls, and the full benefit of any increase in the index if it rises.

In effect this Tessa has all the advantages of a PEP invested to track the FT-SE 100 index and none of the costs or downside risk. There is even a 50:50 Tessa, half of which is equity-linked with the other half guaranteeing a 35 per cent return over the five years.

Latest top Tessa offers

Provider rate% transfer penalty

Best regular savings rate

Chelsea BS 6.25 3 mo notice

Co-op Bank 6.75 pounds 10

Dunfermline BS 6.20 na

First Direct 6.75 14 day notice+0.25pc

Greenwich BS 6.25 60day notice+pounds 25

Harpenden 6.75 pounds 25

Ipswich BS 7.00 1pc fee

Midland Bank 6.75 14days or 0.25pc

Scottish Widows 6.25 28days or pounds 25

TSB 7.00 na

Best variable rate Tessas pounds 1K invested

Beverley BS 6.90 60days notice

B'ham Midshire 7.25 180 days

Coop Bank 6.75 pounds 10

Coventry BS 6.80 7days

Earl Shilton 7.25 nk

First Direct 6.75 14 days int/0.25pc

Furness BS 6.75 nk

Hanley Economic 6.75 7 days

Ipswich BS 7.00 7 days

Loughborough BS 7.00 admin cost

Melton Mowbray BS 7.10 90 days int

Monmouth BS 7.10 1 mo notice

Nottingham Imperial 7.00 90days int

Principality BS 7.25 30 days int

Tipton & Coseley BS 7.00 7days + pounds 30

TSB 7.00 nk

Universal BS 7.10 90 day notice

West Bromwich BS 7.00 28days + pounds 25

Best Fixed rate Tessa pounds 1K invested

Bank of Ireland 7.25F 30 days int +25

Best variable rate Tessas pounds 9K invested

Alliance & Leicester 7.25 60days interest

Allied Trust Bank 7.25 2mo notice +pounds 25

Birmingham Midshires 7.25 180days

Cheltenham & Gloucs 7.25 pounds 30 fee

Greenwich BS 7.25 60days +pounds 25

Principality BS 7.25 30days interest

Best fixed rate Tessas pounds 9K invested

Bank of Ireland 7.25F 30days int +pounds 25

Hoare & Co 7.25F 120days interest

Best variable rate rollover pounds 9K invested

Bath BS 7.50 discretionary

C&G 7.75 pounds 30

Best fixed rate rollover pounds 9K invested

Clydesdale Bank 7.40F pounds 30 + fee

Best follow-on escalators pounds 9K invested

Allied Trust Bank 6.50-9.25 penalty

Royal Bank Scotland 6.75-9.25 5 days+30 day interest

Best follow-on growth Tessa pounds 9K invested

Abbey National 41pc pounds 20

Lloyds Bank 38pc 9 mo interest

Source: MONEYFACTS, NORFOLK