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Tessas taken for granted

Tax-free investments they may be but interest rate rises are passing savers by, writes Steve Lodge
Savings rates are finally taking off after four increases in base interest rates in as many months, rises that have taken the base rate from 6 to 7 per cent. A new round of increases for savers is due to come in this week.

But many thousands of tax-free Tessa savers are finding that they are missing out on much of the good news. Some banks and building societies are failing to pass on interest rate rises in full or even not increasing Tessa rates at all, at the same time, of course, as pushing up mortgage costs significantly. A handful of Tessas from some banks and recently converted societies are now so low that savers might be better off in accounts where they pay tax on the interest. And even among societies that proclaim that as mutuals they give savers a better deal, some appear to be taking advantage of Tessa customers, who are generally more locked in than other savers, by offering good starter rates that then become less competitive.

For example, West Bromwich building society, which claims its Tessa was until recently a "best buy" and which has attracted tens of thousands of savers, has not increased its rate of 7 per cent all year. Its rate is now no better than average and the highest payers are giving around 7.5 per cent, as our Best Savings Rates table on page 13 shows. West Bromwich said it was reviewing rates but could not give details. Meanwhile, as with other lenders, the society has been pushing its mortgage rate ever higher - the latest increase, 0.5 per cent, takes it to 8.45 per cent.

Coventry building society, one of the biggest remaining societies, which last week announced reduced profits and claimed that this reflected the better deal it was giving to savers and borrowers, has given Tessa savers a series of small increases this summer. But even including a 0.2 per cent rise due from this week to 7.2 per cent, it will have raised rates a total of just 0.55 per cent this year, compared with the 1 per cent rise in base rates and a similar increase in its own mortgage rates.

John Thomson, Coventry's deputy chief executive, accepted that Tessa savers were not sharing in rate increases to the degree some other savers were. He said that if, after the latest round of increases, the society's Tessa rates were uncompetitive, it would look again.

Savers with Manchester building society might feel particularly disgruntled. While they too have seen rate rises of just 0.5 per cent this year, this is only to 6.25 per cent and rates are still well below where they were at the beginning of 1996.

"The trouble is they don't need to get the money in now," says Vicki Burn of Moneyfacts, which monitors rate movements, contrasting how rates increases are presently lagging and the higher rates paid by some institutions back in 1996.

Northern Rock, the society soon to become a bank, then paying 8 per cent and last week paying 7.05 per cent on second-generation Tessas, and C&G, the ex-society, then paying 7.75 per cent and last week paying 7.2 per cent, were prime examples of organisations offering artificially high rates to pull in savers. On second-generation Tessas C&G still looks competitive. But its rates for new Tessa savers are now so low that savers would be better off in its top-paying Instant Transfer account, even after paying tax on the interest, assuming they are basic rate taxpayers. Instant Transfer is paying a before-tax rate of 7 per cent from this week on balances of pounds 1,000 upwards. After basic rate tax that equates to 5.6 per cent, which compares with just 5.4 per cent C&G pays on new Tessas. Moreover whereas savings in Instant Transfer can be accessed without penalty by transferring to a bank account, only a proportion of the interest on a Tessa can be withdrawn each year without penalty. To get the full benefits of tax-free savings, savers have to leave their the vast majority of their money untouched for five years.

Savers with dud Tessas are allowed to transfer them without loss of tax benefits, but in most cases they will find they face penalties from the institution they are leaving, and in some cases these are severe. C&G charges pounds 30, while Bristol & West requires three months' notice and deducts the interest that would have been earned in that period.

Manchester building society requires 14 days' notice and deducts the interest, while the Coventry, unusually, has no penalty and just asks for seven days' notice.

Savers picking a Tessa should consider the penalties for transferring or closing account early. In theory lower penalties should exert a pressure on banks and societies to keep rates competitive.

For full details of all Tessas, Moneyfacts, which supplies our Best Savings Rates table on page 13, will send readers a free copy of its latest monthly publication. Call 01692 500765.