Your money: Why we all need tax-efficient investments

All governments in this country exhort us to save more these days, but both Labour and Conservative chancellors treated wages and salaries more favourably than dividends and income by taxing unearned income at higher rates and penalising savings. Recently chancellors have seen the error of their ways and the need to encourage savings and investment by introducing UK tax legislation to encourage us to invest as efficiently as possible. First the surcharge on unearned income was abolished and then a succession of tax-exempt savings and investment products were created.

Just over 10 years ago, Nigel Lawson introduced tax-free personal equity plans, in 1991 John Major brought in tax-exempt savings accounts, and next year we will be able to invest in individual savings accounts.

But still we do not save in as tax-efficient way as we should. A recent survey by IFA Promotions, the trade association which puts people in touch with independent financial advisers, showed that as a nation each year we pay pounds 5.5bn more in tax than we need to, equal to pounds 158 a head. Much of this was due to us not taking advantage of the various tax saving plans that are available.

As we have become more sophisticated about investment, however, the choice of tax-efficient products has grown. Once, the government awarded itself a virtual monopoly on tax-free investments and the National Savings movement was given special tax privileges which banks and building societies could not match. Nowadays, there is wide range of tax-efficient investments.

On the fixed-interest front, National Savings (NS) are often now overlooked, mainly because the interest rates offered have fallen behind those available elsewhere on the High Street. In fact, the Chancellor now expects National Savings to only attract pounds 2bn this financial year against an original target of pounds 3bn.

National Savings do offer a variety of different schemes for both lump sum and regular savings. Some pay out regular income, some accumulate the interest, paying out at the end of a fixed period. Many of the accounts are tax free while others are particularly attractive to non-taxpayers.

The Ordinary Account is the most popular NS product, and over 16 million of us have one. Aimed at small savers, this now pays 2 per cent, but invest over pounds 500 and the interest rate rises to 3 per cent. The first pounds 70 of interest is tax free, or pounds 140 to a couple with a joint account. While building society accounts have almost always paid better even after tax, it was by trooping along to the Post Office with our Ordinary Account savings books as children that most us began to learn about savings.

NS accounts which do compete with other saving schemes include Income Bonds. These are particularly attractive to non-taxpayers and since 8 January they pay 7 per cent gross for deposits under pounds 25,000 and 7.25 per cent for those above. Interest is paid in the form of a monthly income. However, three months' notice must be given of any withdrawal.

Of more appeal to taxpayers are five-year Fixed Interest Savings Certificates, which are tax free. Up to pounds 10,000 can be invested. The current 44th Issue offers 5.25 per cent.

If you are over 60 and want a guaranteed tax-free monthly income, you could look at the National Savings Pensioner Bond. Up to pounds 50,000 can be invested, or pounds 100,000 into a joint account, and it pays out at a rate of 7 per cent fixed for five years after which it can be cashed in.

Other NS saving schemes include index-linked investments, which protect against inflation and special children's bonds. Details of all NS savings should normally be available at your local post office.

There are other forms of tax-free investments for savers to look at. Tax-Exempt Savings Schemes (Tessas) now offer savings plans for investors who are risk-averse. Personal Equity Plans give more adventurous investors the chance to invest in shares and unit trusts tax-free. Friendly societies, often with a very long history, have made a speciality out of catering for those savers who can only put aside a small amount each month.

Even if you have more than pounds 270 a year to invest, they still have products to appeal to those who want to make their money work. Pensions plans are also a form of tax-free investments and savings, although in this case the tax relief is allowed on the contributions and the actual pensions are taxed. This survey looks at the friendly societies and some of the other tax-free ways to save for the small investor.