If you are a taxpayer and plan to leave some money untouched for five years, taking out a tax-exempt special savings account (Tessa) is usually a good idea; your capital will be safe on deposit while the stock market goes through uncertain times.
However, Tessas will be scrapped in April to make way for individual savings accounts (ISAs) with their less generous investment limits. You can invest up to pounds 9,000 over five years in a Tessa compared with pounds 7,000 over the same period in the cash element of an ISA.
In the first year of the Tessa you can put in up to pounds 3,000, followed by pounds 1,800 maximum in each of the next four years, provided you do not exceed the pounds 9,000 limit. A few Tessa accounts require a (taxed) "feeder account," holding the full pounds 9,000 but most allow you to invest with much less.
To earn a tax-free return you must leave the capital untouched for the full five years. Some banks and building societies allow you to withdraw a "net" amount of interest (the amount you would have received if the account was not tax free) without losing tax breaks.
If you need to withdraw capital from your Tessa before the end of the five-year term, it loses its tax-free status and all the interest accrued becomes taxable. However, if you do have to dip into your Tessa early, you will not usually be any worse off than with a standard taxed savings account.
You can choose from a fixed or variable-rate Tessa depending on how much flexibility you need and how you think interest rates will move.
If you expect interest rates to rise over the next five years, a variable- rate Tessa allows you to benefit from these rises as they occur, while a fixed-rate Tessa account will insulate your money from interest rate falls.
But if rates rise a fixed-rate Tessa becomes less attractive and you may have to pay a stiff penalty if you want to access your funds. Once you have taken out a fixed-rate Tessa you may be unable to transfer it as most providers impose stricter transfer penalties than on variable- rate Tessas. You might lose 120-180 days' interest.
A few providers offer stock market-linked Tessa accounts. The basic capital is secure and a token amount of annual interest is paid, while the actual level of interest will depend on share growth.
But if you want to invest in the stock market, you may do better to choose a unit trust or investment trust.
You can withdraw capital from a maturing Tessa and invest it elsewhere or roll over the pounds 9,000 capital into a new Tessa.
To work out whether switching is worth while mid-term, calculate the bonus you might lose and add on any penalty for transferring. Then you can see if a switch would leave you better off over the remainder of the term.
While Tessa operators have to let you transfer out, they don't have to accept transfers into new accounts. So check before you try to switch.
Contacts: Bank of Scotland, 0500 313111; Birmingham Midshires, 0645 720721; Bristol & West, 0800 202121; Clydesdale Bank, 0800 445265; Co- Operative Bank, 0161-832 3456; HSBC, 0800 369000; Investec Bank, 0171- 203 1550; Sun Bank, 01438 744505.
How to pick a good Tessa
Look for a variable rate of 8 per cent or above if you have pounds 500 or more to invest. Bradford & Bingley, Midland Bank and Nationwide BS are among those offering 8 per cent.
Local building society Tessas like Furness BS offer 8.25 per cent for a maximum pounds 9,000 invested.
Fixed-rate deals are harder to find. Abbey National offers 6.50 per cent and Sun Bank 6.75 per cent.
Hybrid stock market Tessas are on offer at Birmingham Midshires, Bristol & West and HSBC.
Many expect you to invest your pounds 9,000 capital, rolled over from the first savings account. You should get 8 per cent interest, though Barclays Bank goes to 8.5 per cent.
Again, local societies offer good deals. Harpenden BS is paying 8.35 per cent on pounds 9,000 invested.
There are more fixed rate deals on offer for follow-on investors. Clydesdale Bank is paying 8 per cent fixed non-compounded. You may do better with 7 per cent at the Co-Operative Bank.
Escalator Tessas pay more interest yearly. Investec Bank pays up to 8.75 per cent in year five and Bank of Scotland 9 per cent.