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Time for a Tessa?

Tax-exempt special savings accounts: they're being replaced in 1999, but these five-year plans still have plenty to offer. Here we look at
TAX-EXEMPT special savings accounts (Tessas) will not shelter your millions from the tax man but they are handy as a modest nest-egg.

Up to pounds 9,000 can be salted away in a Tessa over its five-year life. The Tessa year does not follow the tax or calendar year but starts from the date you open the account.

For new investors, the rules allow up to pounds 3,000 to be invested in a Tessa in year one. Thereafter, pounds 1,800 can be added each year. This means that if you invest the maximum in years one to four, you can only invest pounds 600 in year five.

Aside from the rules about the maximum that can be invested each year, banks, building societies and other Tessa providers often stipulate a minimum investment, typically pounds 1,000 to pounds 3,000. For example, Britannia building society's Platinum Tessa (2nd Issue) demands that the maximum investment be placed in the account each anniversary. However in return, it pays a very good rate, currently, 7.75 per cent.

Some Tessas even ask for the full pounds 9,000 upfront. Money is placed in a "feeder account" and shuttled over to the Tessa each year. Abbey National's Stock Market Tessa is an example of one that uses a feeder account. Returns on this Tessa and the feeder are both reliant on the stock market, with 1.15 per cent gross being added to each balance every month that both the UK's FT-SE 100 Index and America's S&P 500 Index rise.

"The only difference is that returns on the feeder account are taxable but returns on the Tessa are not," says Gug Kyriacou of Abbey National.

Those who have had a Tessa before enjoy slightly more investment freedom than new investors. They can transfer capital from their maturing account into a new Tessa up to the maximum pounds 9,000 if they wish. Any transfer must be made within six months of the old Tessa maturing. If less than pounds 9,000 is transferred, the follow-on Tessa can be topped up with further investments over the five-year term, subject to the usual annual limits.

A number of follow-on Tessas, in particular those paying fixed rate of interest, are only open to investors with the full pounds 9,000 of capital to transfer. These include Halifax, which pays 5.95 per cent fixed a year and a bonus on maturity of 2.5 per cent, and Clydesdale Bank, which pays 8 per cent fixed a year. Interest on the Clydesdale Bank Tessa is paid at the end of the five-year term and promises investors a guaranteed total return of pounds 12,600.

Tessas should enjoy a boom time over the coming year. Although they are being replaced by Individual Savings Accounts (ISAs) in April 1999, any existing Tessas will be allowed to run out the rest of their five-year term. This means investors will be able to shelter up to pounds 9,000 from the tax man until April 2004 if they buy a Tessa at the last minute, and this is in addition to anything they put in their ISA.

On maturity, capital from a Tessa, but not the accumulated interest, will be able to roll over into an ISA - subject to the ISA lifetime limit, currently envisaged to be pounds 50,000 - and continue to attract interest free of tax. ISAs are intended to have a limited cash investment of pounds 1,000 a year but early indications are that investors will be able to maintain the full pounds 9,000 from a Tessa as cash.

A spokeswoman for the Inland Revenue says: "The ISA consultative document states that the method of switching from Tessas will depend on what is practical for investors, providers and the Inland Revenue," which suggests that you would be able to transfer all your capital.

But she adds: "The ISA rules have not been finalised so we cannot [yet] say exactly what the treatment of Tessas will be."

q Contacts: Britannia Building Society, 0800132304; Abbey National, 0800 100801; Halifax, 01422 333333; Clydesdale Bank, 0800 445265.

Take the money and run? Or ignore Bob Hope's advice and put it into a Tessa, available until 1999