Everyone loves Tessa

John Major is not running high in the popularity stakes at present. But there is one measure he introduced that has proved to be highly popular, even if he isn't.

Tax Exempt Special Savings Accounts (Tessas) were first announced in January 1991 by Mr Major, then Chancellor, to promote better saving habits. They succeeded beyond his wildest dreams, with the banks and building societies that provided them vacuuming up billions of pounds from savers in the five years they have been in existence.

Five years later, the first have just reached maturity, prompting speculation about huge walls of money suddenly becoming available for a wide variety of other investments, not to mention holidays, cars and home improvements.

Despite the hopes of many fund managers, tens of thousands of first-generation Tessa holders are considering the benefits of a second fling with the same type of investment.

Their popularity has come despite the seemingly complicated rules involved in setting them up and their arbitrary contribution limits.

The Tessa has significant tax advantages over ordinary savings accounts. Tessa holders can benefit from tax-free interest on their deposit. Tessas are also fairly risk-free products.

Tessas must be run for five years with a maximum deposit of pounds 3,000 in the first year and pounds 1,800 in subsequent years, making a maximum investment of pounds 9,000. If the allowance is not fully utilised in each year, however, the unused residue cannot be carried forward to the following year.

Higher-rate taxpayers have most to gain from Tessas, as they save tax that otherwise would be charged on their investment at 40 per cent.

There is a drawback: if any of the capital is withdrawn before the end of the five years, tax concessions are lost. The one concession is that net income can be withdrawn without penalty.

While low risk, Tessas also have merit as investments in their own right. Present Tessa interest rates hover at around 6 per cent while inflation remains at no more than 3 per cent, leaving the Tessa holder with a real return of at least 3 per cent on a risk-free investment.

Tessas are an ideal component of a balanced portfolio of investments. Over a five-year period there is an attraction in knowing broadly, subject to the general volatility of market interest rates, the returns a Tessa account is going to produce. This is particularly helpful to those engaged in long-term financial planning.

Comparisons are often made between the suitability of a Personal Equity Plan (PEP), another tax-free investment, says Tony Marshall, an independent financial adviser with JN Financial Services.

"The question is always asked as to which is better. The answer is the two products are completely different. They would both usually feature in a balanced portfolio.

"Tessas produce certainty for the more cautious investor. A very poor run for equities over a five-year period - for example, between January 1990 and January 1995 - would, in most cases, see a Tessa as the better- performing product, but this would be exceptional over a longer period of time."

Tessas may be purchased from banks or building societies. The prospect of further de-mutualising by some building societies suggests that they are the most suitable institutions from which to purchase a Tessa.

The Tessa holder may not always qualify for some of the free shares that flow from societies going public, or from loyalty bonuses if they do not. But the prospect is greater than if the Tessa were held with a bank.

Some Tessa providers offer investors the chance to pay over the pounds 9,000 sum at the outset of the five-year period. The provider then undertakes to pay the maximum amount in each year into the scheme. The attraction is that the surplus waiting to be deployed in the Tessa earns attractive rates of interest.

The risk is that the initial rate of interest offered may fluctuate in future years. In addition, the investor should check the penalties charges for withdrawing the money early.

It is advisable to seek independent advice before entering such schemes. Some providers offer investors guaranteed rates of interest over the five- year period often linked to the returns made over the same period of time of investments such the FTSE-100 share index.

These schemes, often designed for the purpose of drawing away money otherwise bound for a PEP, should be checked carefully to ensure that there are no heavy penalties for those who chose to withdraw their money early.

The first Tessas have now matured and the chance hasarisen for investors to reinvest pounds 9,000 immediately in another Tessa for a further five years. The advantage with the second Tessa is that the entire pounds 9,000 can accrued interest-free of tax from the outset. The penalties are the same for those seeking to withdraw their money early.

BEST TESSAS

Company Min. Rate % *

Variable rates

Earl Shilton pounds 1K 7.25

Principality pounds 5K 7.25

C&G pounds 3K 7.20

Fixed rates

Yorkshire pounds 9K 7.30

Bk of Ireland pounds 500 7.25

NatWest pounds 5K 7.05

* Different transfer penalties may apply. Check before purchase.