Tax-Exempt Special Savings Account: Open to shares, but not indecently exposed

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The Independent Online
If you want to share in the excitement and potential gains of the stock market but are not keen on the risks, an equity-linked Tessa may be the answer.

Like all Tessas, these are tax-free savings accounts. But instead of receiving a fixed or variable rate of interest from the bank or building society, the interest paid on your account is linked to the performance of the market.

There is no risk to your original investment and several equity-linked Tessas guarantee a minimum amount of interest at the end of the five-year term.

These Tessas are offered by Abbey National, Birmingham & Midshires Building Society, Bristol & West Building Society and HSBC, the parent company of Midland Bank.

Each account is slightly different. For example, one of HSBC's Tessas guarantees to pay 5 per cent interest on an investment each year regardless of the performance of the stock market. If the market grows by more than 25 per cent over five years, you get a 1 per cent bonus for each additional 1 per cent it has increased by over this period, up to a maximum bonus of 37.5 per cent.

Other equity-linked Tessas will instead offer, say, 150 per cent of any growth in the market.

Typically, the higher the level of guaranteed return, the less you can expect to share in any gains on the stock market.

Some equity-linked Tessa accounts require an investment of pounds 9,000, and are only available to people on their second Tessas with pounds 9,000 of capital to roll over into a new account. But the Bristol & West offers an equity- linked Tessa which accepts a minimum investment of pounds 3,000, and HSBC's follow-on investment will accept pounds 6,600. Gug Kyriacou, a spokesman for Abbey National, says: "This type of Tessa allows you to dabble with the excitement of the stock market, but you don't expose your capital to risk."

But the disadvantage with such accounts is that you do not get the full benefit of any gains on the stock market. Not only may the level of gains on your Tessa be capped, but you do not earn dividends which you would get if you invested directly in shares. And while if the market falls you will get your original investment back, you may have earned no interest on your money over the five-year term.

As these Tessas vary, you should look at how the growth in the FT-SE index of leading shares is measured. To avoid exposing investors to the risk of the market falling just as their Tessa comes up to maturity, most providers will average out the growth of the index over the last six to 12 months of the Tessa.

But if this process is more prolonged, you could lose out, according to Simon Pratt of the Bristol & West.

"Averaging is good in the last six months of the Tessa as it locks in any growth over the five years," he explains. "But if you start to do averaging for periods longer than this, you begin to restrict the growth potential of the Tessa."

If you are looking to take a first step into stock market investment, this type of Tessa could be a good start. But you must be aware that in most cases your money is locked into these accounts, you cannot take the cash out or transfer it to another Tessa provider without paying such a hefty penalty that you would lose heavily.

So before opening one of these accounts a sensible course would be to have some "rainy day" funds in a more accessible account and make sure that you will not need the money going into the equity-linked Tessa for the next five years.

Abbey National and Birmingham Midshires say flatly that they do not allow transfers before maturity, while Bristol & West requires six months' notice for transfers plus a punitive pounds 1,000 to cover its costs. HSBC requires 90 days' notice and charges a penalty of up to 2 per cent of the balance on the account.

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