Money: Tax treats go begging

Most people would prefer not to pay tax on the interest earned on their savings. Yet schemes that offer the perk, such as various National Savings, Tessas and friendly society bonds, are often overlooked, says Abigail Montrose.

These schemes may offer tax-free interest, but that does not mean they offer the best deals on the market, however.

While the tax-free rates on the National Savings Ordinary Account are competitive, there are better deals around. Sainsbury's Bank is paying 6.5 per cent gross interest on its instant access account which can be opened with pounds 1. Even after paying tax on your interest, that is significantly more than you would earn from the Ordinary Account.

For those willing to lock up their money for five years, National Savings offers Index-linked certificates (11th issue) which pay 2.75 per cent interest plus the rate of inflation free of tax, and fixed-rate Savings Certificates (44th issue) which pay 5.35 per cent tax free.

Those are particularly good value for higher-rate taxpayers who would need to find an equivalent account paying 8.92 per cent gross to match them.

Even better rates are available on Tessas (tax exempt savings accounts) from banks and building societies but the maximum that can be invested is pounds 9,000. The best Tessas often are offered by small building societies such as the Cambridge and Kent Reliance, which is paying 7.6 per cent. But that is available only to people living in the local area.

Savers also need to watch out for minimum investment levels. For example, Principality is offering 7.65 per cent on its Tessa but the minimum investment is pounds 2,500 for anyone who does not live locally. Hanley Economics Building Society and Midland Bank will let you open a Tessa for pounds 100 and pay 7.6 per cent and 7.5 per cent respectively.

Ten-year savings bonds are offered by friendly societies. You can invest up to pounds 25 a month in just one of them and as long you keep it going for at least 10 years, the proceeds are paid tax free.

Charges are high because part of your money goes towards paying for life insurance. Figures from Homeowners Friendly Society show that if you invested the maximum over 10 years, pounds 598 or 19.9 per cent of your contributions would go in charges. Assuming the fund you invested in grew by 9 per cent a year, the actual return on your investment after 10 years would be only 4.7 per cent a year after charges.

Peter Stanford, head of marketing at Homeowners, says the charges work out cheaper as a percentage of the overall return if investors keep their bond for more than 10 years. "If the bond is held for 15 to 20 years, the impact of our charges is greatly reduced."

But watch out. If you need your money before the 10th anniversary of the bond, the penalties are stiff and you may not even get back your original contributions.