Poachers open up on Tessas

Battle is being joined for pounds 24bn of accounts.

A battle for control of pounds 24bn of tax-exempt special savings accounts or Tessas is beginning to hot up, and there are signs we could be in for a war if Tessa providers start trying to poach renewal business from each other.

The first shots are being fired by Save & Prosper, the savings and investment arm of the merchant bank Robert Fleming, which is floating new Tessa products now in the hope of catching the eyes of more than four million Tessa investors and tempting them to transfer.

The Tessa was invented by John Major when he was briefly Chancellor in 1990, and allowed investors who put money into a Tessa account to keep the interest free of income tax provided they held the account for five years. Investors can invest pounds 3,000 in the first year, and pounds 1,800 in years two to five, building up to a maximum of pounds 9,000.

Tessa holders are already free to transfer funds to another provider if they want without losing tax advantages. The great majority have stayed loyal, partly through inertia, partly because most Tessa providers built in transfer penalties and/or terminal bonuses when most accounts were opened in 1991, and most holders will want to stay the course.

There are now 4.05 million Tessa accounts, but 98 per cent of them were first opened in the first six months of the scheme in 1991, and will have completed their qualifying period within the first six months of 1996. The holders will then be completely free to shift their Tessas to another home without risk of penalties or loss of their tax advantages.

Almost 60 per cent of holders have taken their full entitlement each year and already hold the pounds 9,000 maximum allowed. Another 28 per cent made an initial deposit and have not added to it since, either because they had no more spare capital and could not manage to save anything more out of income, or because they were disillusioned by the drop in the interest rates they could earn.

When Tessas were first introduced interest rates were well into double figures and rates of 14 per cent tax-free were on offer. But virtually all Tessas have been variable rather than fixed-rate offers and the interest earned has fallen steadily to a low of around 6 per cent last year before starting to edge higher. Most variable-rate Tessas now offer 6.5-6.75 per cent.

The Chancellor, Kenneth Clarke, signalled his intention of renewing and rolling over existing Tessa rules in his Budget last November, allowing investors to keep their existing pounds 9,000 maximum and add a similar sum over the next five years.

But many banks and building societies have expressed concern that, with interest rates currently half the initial levels of 1991, investors may be tempted to take their tax-free entitlement and invest it in higher- yielding products and more flexible tax-free products such as the fashionable corporate bond personal equity plans.

With one eye on the competition, Save & Prosper this week announced a new Tessa account paying a guaranteed fixed 7.5 per cent tax-free for the next five years. It guarantees that an initial deposit of pounds 9,000 from an existing Tessa will grow to pounds 12,920 by 2001 if no interest is withdrawn.

If investors transfer their existing Tessas to S&P it is also offering to pay the 7.5 per cent on the entire balance of all Tessas transferred from another provider until the maturity date of those existing accounts. The offer is open to all holders of Tessas maturing in the first five months of 1995 provided they agree to open another Tessa with Robert Fleming.

Investors who do not at present have a Tessa can also invest up to the maximum of pounds 3,000 for a first year's instalment and qualify for the 7.5 per cent guaranteed rate, although additions in subsequent years will qualify for whatever is the going rate at the time they are made.

Investors who want to take income from their Tessa will be paid a guaranteed 7.3 per cent tax-free payable every three months. The Tessa will, however, be invalid if any capital or more than 75 per cent of the accumulated interest is withdrawn.

Barclays Bank announced a new fixed-rate Tessa two weeks ago, offering a guaranteed 7.4 per cent tax-free for two years, after which the rate will revert to the going variable rate at the time. Other providers are actively considering plans for long-term sweeteners to persuade existing holders to stick with them and up-front offers probably for a limited period to tempt others to transfer across.

Investors can expect announcements any time, but should wait until all the offers are on the table before taking any action.