Wooing Tessa's admirers

PERSONAL EQUITY PLANS PEPs will be one destination as up to pounds 15bn in maturing deposits seeks a new home from January
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MILLIONS will soon benefit from thousands of pounds of maturing Tessa money. About pounds 15bn of Tax Exempt Special Savings Accounts begin maturing in January, and although most will probably want to keep their money in the building society, investment companies hope some will opt for a more adventurous investment - such as a PEP.

Mary Blair, an executive director with Fidelity, a PEP firm, believes that as much as a quarter of the money coming out of maturing Tessas will find its way into PEPs. This could mean billions of pounds of new PEP investment.

Ms Blair said: "There has been a significant drop in interest rates since people started taking out Tessas. Unless there is a dramatic hike in rates in the next couple of months, building society products are going to look less attractive."

For savers who chose one of the higher-paying building societies, a Tessa with the maximum pounds 9,000 investment will be paying out close to pounds 13,000. Ms Blair said current interest rates meant the same level of Tessa investment was now offering a return of about pounds 11,000. "pounds 9,000 growing to pounds 11,000 is not so attractive, given that you've got to tie the money up for so long," she said.

Investments in PEPs are sheltered from income and capital gains tax, thus making them superficially similar to Tessas. However, as their name indicates, PEPs are primarily intended for investing in equities (shares).

Their structure and rules make them far more flexible than Tessas. An investor can cash in any of his or her investment at any time without losing the PEP tax advantages. A building society or bank must immediately close the account of someone who wants to withdraw capital from a Tessa, and any interest earnt is subject to tax at the saver's highest rate of income tax.

But although a PEP can hold out the promise of better returns than a Tessa, it involves much greater risks. PEPs typically cannot guarantee the return of capital, let alone profits. Like other deposit accounts, Tessas put safety first. Money invested will grow steadily, perhaps slowly, but investors can be sure they will get their money back.

Most of the savings in Tessas are considered by many to be natural building society money - about 80 per cent of the initial investments came from existing building society accounts. The banks and building societies therefore expect most to be rolled over into second-generation Tessas.

The Government made this option more attractive last year when it decided to allow the full pounds 9,000 maximum to be switched into a new Tessa. Previously the maximum first-year investment was pounds 3,000. Surveys have suggested that nearly three-quarters of all Tessa savers intend to open a new one.

The banks and building societies are writing to encourage savers to do just that. Halifax Building Society, which has a quarter of the Tessa market, is offering a pounds 50 bonus to customers who opt to reinvest in "Tessa 2" before the maturity of their existing accounts.

Halifax is offering its Tessa depositors a range of options, including a PEP from its life insurance arm. Some people will use their Tessa proceeds to take the holiday of a lifetime, or to pay off part of their mortgages. But Paul Duffin, the assistant general manager at Halifax, believes nearly all the money will remain in some form of savings.

Halifax customers have an added incentive to keep their money with the building society because of the expectation of receiving shares in the planned stock market flotation. Withdrawing Tessa money could affect eligibility. Customers of National & Provincial Building Society, which is being taken over by Abbey National, are in a similar position.

But even those investors who decide to roll pounds 9,000 of Tessa capital over may have to find a new home for the interest. Many PEP companies believe savers will be interested in bond PEPs that invest in the debt securities issued by large companies.

The attraction for investors is that corporate bond PEPs can pay better interest rates than Tessas, while avoiding some of the risks of share PEPs. For example, Perpetual's corporate bond PEP fund is yielding 7.95 per cent.

Roger Cornick, the deputy chairman of Perpetual, said: "A lot of Tessa investors will be unwilling to go back into that environment because of the market reduction in interest rates. They would be better advised to look at corporate bond PEPs, where they will get a better return for their money."

Fidelity, which is planning a PEP marketing campaign aimed at Tessa savers, is hoping to persuade some investors to make the move into equity PEPs.

Investors should look out for any changes to either Tessas or PEPs in the Budget. The rule is to stick to an investment you feel comfortable with and understand. If in doubt, talk to an independent financial adviser.