Midweek Money: Make friends with a nice little earner

PEP managers and Tessa providers are counting down the days until April 1999, when their products may no longer be sold and will be replaced by new-style Individual Savings Accounts. For the UK's friendly societies, however, the new ISA accounts will represent an additional opportunity.

The Chancellor has announced that friendly societies will be able to offer ISAs, in addition to their existing tax-free 10-year savings plans. It effectively means that they will be able to compete on more or less level terms with the big institutions when it comes to attracting savers.

However, the chances of friendly societies spending massive amounts on advertising new ISAs is slim. In reality, they are likely to continue offering their members a range of products with few frills or costs.

At the heart of the friendly society deal is the 10-year savings plan. These accounts can offer tax-free savings because they contain an element of life assurance. "Friendly societies provide a nicely packaged savings product which grows tax-free," says Barry Chambers, marketing director at Family Assurance, one of the leading societies. "A lot of people earmark the cash for a particular event, such as wedding anniversary celebrations, or just some cash for children or university costs."

The Government is keen to encourage people to have adequate life assurance and that's why the plans are granted tax-free status. However, the life assurance element of the plan is pretty small and the accounts are generally sold as savings schemes.

The maximum monthly amount you can put into a friendly society 10-year savings plan is pounds 25, or savers. can invest up to pounds 270 a year. To get the full tax-free status, the plans must be maintained for 10 years - cashing in early could mean a tax liability or the return of less than you've paid in.

Worse, if the plan is closed before 12 monthly payments have been made, there will be no return of cash at all. This is because of the life assurance element. Payments in the early years predominantly go towards paying those charges. However, some of the cash will also be invested on your behalf to ensure a pay-out after 10 years.

The investment is managed in much the same way as any other - by professional fund managers who use their expertise to get maximum returns. In essence, the plans work in exactly the same way as endowment policies where some of the premiums pay for the life cover, and the rest is invested on your behalf.

Returns on the friendly society plans will be hit by the cost of life cover and expenses and charges, although friendly societies - stung by criticism about the size of charges - have been working hard to reduce costs as much as possible. But an illustration from Homeowners Friendly Society shows that someone investing the maximum amount each month - 3,000 over 10 years - would pay pounds 598 in deductions, producing a real effect of a pounds 970 deduction from their fund. These deductions would bring investment growth of 9 per cent down to just 4.7 per cent a year.

But not using a friendly society savings plan means losing out on the tax benefits. IFA Promotion, a marketing body promoting independent financial advice, calculates that people already saving with an endowment policy are wasting pounds 50m a year in tax by not saving in a friendly society.

"Too many people overlook friendly societies when planning their savings and investments," says David White, head of sales and marketing at Tunbridge Wells Equitable. "As far as using their tax-free premium allowances is concerned, my advice is use it or lose it."

There are, in fact, hundreds of friendly societies around the country, but only a few offer products to the general public. Most restrict themselves to providing a range of benefits for their members. The largest national friendly society is Liverpool Victoria.

Looking ahead, the societies would like to see an increase in the amount of cash people can save in their 10-year plans. "We would like to see the Chancellor increase the limit," says Barry Chambers. "The accounts are already attractive to those who like having to save regularly. An increased limit would improve the attraction."