Tessa charms the saver who can wait

PEPS AND TESSAS Tax-free accounts lack flexibility but the rates offered are much better, writes Mark Battersby
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INTEREST rates on Tessas are looking so good that it is hard to see why people should invest in other bank and building society deposit accounts.

Tessas already have the built-in advantage of paying interest tax-free so long as most of your money is left in place for five years. But fierce competition to win business from investors with maturing Tessas has pushed up rates to what can be argued are artificially high levels.

According to Chase de Vere, an independent financial adviser, leading variable-rate Tessas for people with money from maturing accounts are offering between 7.5 and 8 per cent. The highest fixed-rates available top 7 per cent.

In contrast, the best 90-day notice accounts fail to breach the 7 per cent interest level - and that interest is taxable. The small Catholic Building Society pays 4.35 per cent net for a minimum of pounds 2,000 while Alliance & Leicester pays 4.95 per cent net for a minimum of pounds 10,000.

Only when the minimum investment hits around pounds 25,000 does the gross rate go above 7 per cent. The Alliance & Leicester pays 7.1 per cent gross or 5.32 per cent net for a pounds 25,000 investment.

For six-month notice accounts, the Portman Building Society pays an attractive 4.01 per cent net on pounds 500, Halifax 4.27 per cent on pounds 2,000 and Bristol & West 4.65 per cent on pounds 5,000.

Among instant access accounts, the postal account offered by Bristol & West Direct pays 4.01 per cent net on pounds 5,000, while West Bromwich offers 4.5 per cent net for just pounds 2,000. Most savings rates are much lower.

One question that investors must consider is whether the relatively high rates offered by Tessas today can be sustained in the future.

Some banks and building societies offered enticing rates in 1991 when Tessas were launched but these subsequently became less competitive. Of course interest rates fell generally over this period, but in some cases the tax-free rate on Tessas fell lower than the equivalent gross rate on a comparable deposit account, and in extreme cases the Tessa's tax- free rate was lower than that of the best-paying accounts after tax.

Investors must also weigh up carefully whether Tessa rates are good enough to justify their inflexibility compared to other bank or building society accounts. Money invested in a Tessa must be left untouched for five years if the interest is to be paid tax-free. Inland Revenue rules compel the closure of a Tessa account if any of the capital is taken out. If a Tessa is closed, any accrued interest becomes taxable and the building society or bank may also levy an additional financial penalty.

It is possible under the tax rules to withdraw interest from a Tessa but not all banks or building societies offer this option. Such withdrawals will be net of basic-rate tax and may also incur extra charges. The tax- free element of the interest must remain in the Tessa until the end of the five-year period.

On the whole, though, it is probably worth sacrificing access to money for the better returns that second-generation Tessas are providing.

Their restrictions do encourage a savings discipline. The value of the returns being tax-free should not be underestimated, particularly for higher-rate taxpayers. A 40 per cent taxpayer would need to hunt down a taxed deposit or other investment yielding 13.3 per cent to match the gross 8 per cent return from the Northern Rock.


Follow-on Tessas

Minimum Rate % Transfer interest deposit penalty

Northern Rock pounds 9,000 8.00 pounds 30 +

C&G pounds 9,000 7.75 pounds 30

Bath pounds 1 7.50 Discretionary

Mercantile pounds 1 7.50 pounds 30

Northern Rock pounds 3,001 7.50 pounds 30+

Allied Trust Bank pounds 9,000 7.25 pounds 25

Clydesdale Bank pounds 9,000 7.40F1 pounds 30 +

West Bromwich pounds 3,000 7.35F 180 days

Yorkshire pounds 9,000 7.30F Up to 180 days

Bank of Ireland pounds 500 7.25F pounds 25 + 30 days

Birmingham Midshires pounds 1,000 7.05F 180 days

NatWest Bank pounds 5,000 7.05F 180 days

Royal Bank of Scotland pounds 9,000 6.75F-9.25F13 30 days

Allied Trust Bank pounds 9,000 6.25F-8.75F3 Unspecified

First Tessas

Minimum Rate % Transfer interest deposit penalty

Yorkshire pounds 9,000 7.30F Up to 180 days

Earl Shilton pounds 1 7.25 -

Principality pounds 25 7.25 30 days

Bank of Ireland pounds 500 7.25F pounds 25 + 30 days

C&G pounds 3,000 7.25 pounds 30

Allied Trust Bank pounds 9,000 7.25 2 mths notice +pounds 25

Dunfermline pounds 3,000 7.20 -

Market Harboro' pounds 9,000 7.15 90 days

Monmouthshire pounds 1 7.10 -

Universal pounds 1 7.10 -

Melton Mowbray pounds 1 7.10 90 days

NatWest Bank pounds 5,000 7.05F 180 days

Hinckley & Rugby pounds 3,000 7.052 90 days

TSB pounds 250 7.00 -

Cambridge pounds 1 7.00 pounds 25

Tipton & Cosely pounds 1 7.00 pounds 30

Follow-on Tessas are available to holders of maturing first-issue Tessas. Follow-on Tessas in this selection open to all. Many institutions have launched exclusive issues for their existing Tessa customers, so it is wise to check what is on offer from your present provider.

Key: F=fixed interest; 1 interest not compounded; 2 Feeder a/c part of deal; 3 Fixed rates increase by steps over five years - highest rate only in year five. Source:Moneyfacts