The time is ripe for Tessa holders

Billions of pounds of Tessas are about to mature. That's a lot of cash looking for a home. By Clifford German

D-Day is fast approaching for holders of literally billions of pounds worth of tax-exempt special savings accounts (Tessas), who will have held their accounts for five years and will start to qualify to withdraw them without losing the tax-free interest they have been accumulating.

Individuals are allowed to invest up to pounds 9,000 each in a Tessa, starting with up to pounds 3,000 in the first year, pounds 1,800 in each of the next three years and the balance in year five. The capital in a Tessa is not at risk, and the interest will be tax-free if the capital stays untouched over the five years after the account was opened.

There is an estimated pounds 25bn invested in Tessas, of which more than pounds 12bn was invested in the first six months of 1991 alone, when interest rates of 13 per cent tax-free were briefly on offer. The build-up has been slower in recent years, but the Chancellor confirmed last year that all the accumulated capital in maturing Tessas can be rolled over into a new Tessa, provided it is done within the first six months after maturity.

That means pounds 12bn available for re-investment or redeployment in the next six months, but the accumulated interest, totalling at least pounds 3bn in the first six months of 1996 alone, will not be eligible for rolling over, and will have to find another home.

Where will they go? Tessa savers are risk-averse, and they like their Tessas. But interest rates have halved since 1991 and might be going lower still. Faced with a possible massive loss of funds the banks and building societies that offer Tessa accounts are trumpeting their performance over the last five years, and publishing league tables. Among the top 20 banks and building societies Cheshire Building Society and Bradford & Bingley head the list (see table). But according to Money Facts several smaller providers did better still, led by Kent Reliance Building Society, which generated pounds 12,400, Dunfermline BS, National Counties BS, Julian Hodge Bank and the Melton Mowbray Building Society.

The bigger players are already dangling the prospect of extra attractions to persuade investors to renew their Tessas. Abbey National has announced three new Tessa accounts. The Tessa 3rd edition offers tiered rates that offer 5.85 per cent on amounts up to pounds 3,000, rising in steps up to 6.6 per cent for the maximum level of savings, and is available to both new and roll-over investors.

Investors with a maturing Tessa fund of pounds 9,000, however, are being offered a fixed-rate Tessa paying 7 per cent guaranteed, paid annually, plus a bonus structure which allows investors a 1 per cent bonus payable at maturity for every year in which average base rate has risen more than 1 per cent over the previous year.

The guaranteed-growth Tessa is also available only to existing Tessa holders with a pounds 9,000 maturing fund. It guarantees a 41 per cent return on the capital over five years and has the same bonus structure if base rates rise.

Abbey National is also offering investors a two-year fixed interest bond, paying a minimum of 4.88 per cent net, for those who do not want to tie their money up for another five years or who have accumulated interest which they are not allowed to carry forward into a new Tessa.

Bradford & Bingley is offering its existing Tessa customers a fixed rate follow-up Tessa for the full pounds 9,000 and a one-year special interest bond for maturing interest. It is offering a loyalty bonus of 0.75 per cent a year tax-free if they roll over an existing Tessa account with a minimum of pounds 500 into a new variable rate Tessa and keep it for a further five years. Including the bonus, the initial rates are 6.5 per cent on amounts up to pounds 3,000, rising in steps to 7.5 per cent on a full pounds 9,000 roll-over. Rates can fluctuate but are guaranteed to be higher than balances in a 90-day account. Investors with at least pounds 3,000 in Tessas from other providers are being offered a 0.5 per cent sweetener to switch to Bradford &Bingley.

Woolwich has similar ideas, and is offering a 0.25 per cent special bonus to roll-overs into a variable rate Tessa that starts off paying 6.1 per cent on amounts up to pounds 6,600, rising to 7.05 per cent on a maximum pounds 9,000 roll-over. Existing Tessa holders can also choose to roll over into an escalator Tessa, which will pay 5.75 per cent tax-free in the first year, rising in four annual steps to 10 per cent in the final year. Woolwich is also offering investors a new corporate bond Pep, available on 2 January, with an estimated tax-free yield of 7.1 per cent after deducting an annual management charge of 1.25 per cent. There will be no initial charge for early roll-overs.

Cheltenham & Gloucester, HSBC Investment Bank and Barclays Bank have also recently announced special new options. HSBC Tessa Plus will offer 5 per cent a year guaranteed, plus a bonus of up to 30 per cent extra, making a 55 per cent total return if the top 100 shares on the London stock market rise by that amount.

Barclays is offering its customers with maturing Tessas only a new fixed rate Tessa earning 7.5 per cent tax-free that is expected to turn pounds 9,000 into pounds 12,921 in five years' time. You can expect similar sweeteners from all the big players in the Tessa market.

Fixed-rate Tessas actually did better than variable rate ones over the last five years, but there were not many of them, and it is hard to see providers rushing to offer attractive fixed rates while interest rates are falling. In spite of consumer loyalty and caution if interest rates continue to edge lower the attractions of tying money up in Tessas for another five years, with or without the prospect of a loyalty bonuses, are no longer irresistible, and suppliers of other financial products are also touting their wares in the hope of attracting a slice of the maturing Tessa money.

The immediate rivals include personal equity plans, which like Tessas are tax-free. Unlike Tessas they can drop in value, but most would have out-performed Tessas over the last five years.

Corporate bond Peps currently earn more than a Tessa but can lose value if interest rates rise. Guaranteed income bonds have their supporters. So do guaranteed stock market bonds, which combine guarantees of the capital invested with possible capital gains if the stock market rises over the next five years. We shall look at these options in the next few weeks. Another less conventional alternative is to invest in traded endowment policies (see accompanying article).

BEFORE YOU ROLL OVER

Do

Remember that Tessa accounts must be held for five years to escape tax.

Bear in mind that interest rates and returns on Tessas in the next five years may be less than in the last.

Look around at the alternatives which may earn a lot more for relatively little risk.

Don't

Forget that the accumulated interest in your Tessa cannot be re-invested in a new Tessa.

Be in a hurry to roll your Tessa over without looking around to see what competing Tessa providers offer.

Forget you have six months from the time your present Tessa matures to decide.

The best returns

Summary of five-year returns. (pounds 9,000 invested over five years)

Rank Provider Five-year maturity value return % pa

1 Cheshire BS 12,097.11 8.55

2 Bradford & Bingley 12,093.40 8.55

3 Derbyshire BS 12,056.81 8.46

4 Halifax BS 12,040.86 8.42

5 Bristol & West 12,019.36 8.36

6 Woolwich BS 12,011.61 8.35

7 Leeds & Holbeck BS 11,975.10 8.26

8 Yorkshire BS 11,959.00 8.22

9 National & Provincial 11,946.07 8.18

10 Coventry BS 11,935.13 8.16

11 Skipton BS 11,928.70 8.14

12 Britannia BS 11,922.35 8.13

13 TSB 11,904.68 8.08

14 Northern Rock BS 11,875.59 8.01

15 Cheltenham & Gloucester 11,872.70 8.00

16 Royal Bank of Scotland 11,870.47 8.00

17 Nationwide BS 11,869.97 8.00

18 Alliance & Leicester 11,844.87 7.93

19 Leeds Permanent BS 11,841.24 7.92

20 Abbey National 11,830.92 7.90

21 Birmingham Midshires 11,820.86 7.87

22 Chelsea BS 11,807.24 7.84

23 Portman BS 11,783.36 7.78

24 Bristol & West BS 11,777.90 7.77

25 NatWest Bank 11,659.55 7.47

26 Lloyds Bank 11,522.30 7.12

27 Barclays Bank 11,493.67 7.05

28 Midland Bank 11,492.46 7.04

Source: Blay's MoneyMaster