Savings that really perform

savings plans

ONE OF the main attractions of PEPs is that they are completely tax free - there is no tax on capital gains, and the tax credit on dividends can be reclaimed. But they are far from being the only tax-free investment. While no-one should pick an investment simply because it has tax advantages, freedom from tax can change a good investment into a great performer.

One of the more recent arrivals is the Tax Exempt Special Savings Account, or TESSA. Announced by John Major in his one and only budget as Chancellor of the Exchequer in 1990, they first became available in January 1991.

A TESSA is a building society or bank account on which interest can be paid tax free. The total amount that can be invested into it is £9,000, with a limit of £3,000 in the first year and up to £1,800 a year in the next four years. The account matures after five years, and the capital and interest can be withdrawn.

Before maturity, only the net interest can be withdrawn. If more is taken out, the TESSA has to be closed and the interest accrued so far all becomes chargeable to tax immediately.

TESSAs appeal to the less adventurous who are wary of the ups and downs of stock market investment through a PEP. For those who want not only security of their capital and freedom from tax, but who also want to know what return they are going to get on their investment, National Savings Certificates are the answer. They offer a fixed, tax-free return after five years investment. The rates vary with each new issue; the current issue is the 42nd and the rate of interest is 5.8 per cent per annum. But beware - that rate will only apply if you hold the certificates for the full term. Cash them in earlier and the rate drops.

Many investors believe that all National Savings investments are tax free. This is not so, as taxpayers often find to their cost. This is particularly true of the National Savings Investment Account. It pays interest gross, but taxpayers have to declare the income to the Inland Revenue.

However, one National Savings investment which is tax free, and which combines security of capital with the National Lottery, is the much maligned premium bond. Although the prize money received by any one investor can never be guaranteed, the total amount distributed each year is 5.2 per cent of the value of the bonds in issue. That is a good rate of return for a higher rate taxpayer, and provided he or she holds a few thousand pounds in bonds, the large number of small prizes should result in an income.

For the small but regular saver, friendly societies have always offered a tax-free return on a ten year life endowment policy. However in the past the limit on the premiums, which they can take has meant the administration costs have often swallowed up much of this benefit.

Steady increases in the permissible premiums over the past five years, from £100 in 1990 to £270 once the latest Finance Act is passed, mean that this is no longer the case. The new limit means that, if a husband and wife each take out a policy, together they can save a total of £45 a month in a tax-free savings plan.

This is likely to give a better return than an equivalent policy with a life assurance company, since when an ordinary endowment matures, the life assurance company has had to pay tax on the profits and gains it has made.

But the most tax efficient investment is one which most people do not think of as an investment at all - contributing to a pension fund. Unless they are in one of the best company pension schemes and intend to remain with the same employer for forty years, most people will not receive the maximum pension which they are entitled to under Inland Revenue rules.

Workers who are in a company scheme can increase their pension by saving through additional voluntary contributions. Those who are not in a company scheme, or who are self-employed, can contribute to a personal pension plan.

In either case there is a double tax advantage. First, the premiums attract tax relief provided they are within Inland Revenue limits, and second its tax free.

Contributing more to your pension scheme may not be a particularly novel form of investment, but it has the best tax treatment on offer.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Executive - OTE £40,000

£15000 - £18000 per annum: Recruitment Genius: This is a great opportunity for...

Austen Lloyd: Law Costs HOD - Southampton

£50000 - £60000 per annum + Excellent Salary: Austen Lloyd: An outstanding new...

SThree: Recruitment Resourcer

£20000 - £21000 per annum + uncapped commission: SThree: As a graduate you are...

Ashdown Group: Junior Application Support Analyst - Fluent German Speaker

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Day In a Page

Syrian conflict is the world's first 'climate change war', say scientists, but it won't be the last one

Climate change key in Syrian conflict

And it will trigger more war in future
How I outwitted the Gestapo

How I outwitted the Gestapo

My life as a Jew in wartime Berlin
The nation's favourite animal revealed

The nation's favourite animal revealed

Women like cuddly creatures whilst men like creepy-crawlies
Is this the way to get young people to vote?

Getting young people to vote

From #VOTESELFISH to Bite the Ballot
Poldark star Heida Reed: 'I don't think a single bodice gets ripped'

Poldark star Heida Reed

'I don't think a single bodice gets ripped'
The difference between America and Israel? There isn’t one

The difference between America and Israel? There isn’t one

Netanyahu knows he can get away with anything in America, says Robert Fisk
Families clubbing together to build their own affordable accommodation

Do It Yourself approach to securing a new house

Community land trusts marking a new trend for taking the initiative away from developers
Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

Money, corruption and drugs

The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

150 years after it was outlawed...

... America's first slavery museum is established in Louisiana
Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
Tony Oursler on exploring our uneasy relationship with technology with his new show

You won't believe your eyes

Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

Moores must go. He should never have been brought back to fail again

The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn