Small is beautiful with Tessa

Maturing Tessas (Tax-Exempt Special Savings Accounts) were the hottest financial property for weeks on end twelve months ago when the the first Tessas taken out in 1991 qualified for their tax-free payouts.

Things are a bit different this year. The new crop of Tessas maturing in 1997 were started in 1992, and investors who took out a variable rate Tessas then missed the boat of initially high interest rates which attracted almost pounds 12bn in Tessas in 1991.

The best guess is that something like pounds 5bn worth of Tessas mature in 1997, and the average pay-out for the maximum investment of pounds 9,000 spread over five years will be around pounds 11,500, compared with an average pounds 12,000 for the early birds who invested in 1991.

With fewer Tessas maturing there is less of a scramble to attract the maturing funds, but individual investors still have to decide what to do with their pay-outs. Investors are not allowed to reinvest the interest they have earned on a maturing Tessas, but they are allowed to keep the capital in a (taxable) deposit account for up to six months before deciding to reinvest the capital in a roll-over Tessas.

If last year is any guide around 70 per cent will simply be reinvested straightaway in follow-on Tessas and in spite of the publicity the wide range of performances received, most accounts were rolled over with the same provider, usually their "local" bank or building society, reflecting the inertia affecting long-term savers.

Investors with maturing Tessas they wish to re-invest need to decide two things. Should they take advantage of the freedom to transfer maturing funds without penalties and shop around for a better rate with a different provider? And should they go for a fixed rate which will not change over the next five years or take a chance on a variable rate, which the provider is free to raise or lower at their own convenience?

The evidence suggests that small providers try harder and offer better rates. The best Tessas which will be maturing in 1997 came from small providers, just as they did in 1996. But only five of the top ten variable- rate Tessas maturing in January 1996 are also in the top ten just coming up for redemption in January 1997, according to Moneyfacts, the data-base providers for the financial services industry.

Hanley Economic Building Society jumps from 49th place a year ago to top place for variable-rate Tessas maturing next month, and will be returning savers a juicy pounds 11,917.62 tax-free on a maximum investment of pounds 9,000 made over the past five years. Julian Hodge Bank comes in second, with pounds 11,804.37, up from fourth in the accounts which matured a year ago.

But the past is not always the best guide to the future. The best provider of Tessas which matured a year ago was Kent Reliance Building Society which paid out pounds 12,400 for maximum holdings in January 1996. In the latest list however it has dropped to 15th out of 90 providers identified by Moneyfacts.

The average return on newly maturing Tessas is pounds 11,491, which is about pounds 500 less than the first Tessas maturities paid out twelve months ago, but the range between best and worst is again over pounds 1,000. Sadly the big clearing banks come out once again as relatively poor homes for Tessas. The TSB (now part of Lloyds) did best, taking 26th place with an estimated pay-out of pounds 11,613.28. Royal Bank of Scotland takes 56th place, closely followed by Abbey National, but Natwest is only 73rd, Barclays 78th, Lloyds 80th, Bank of Scotland 84th, Clydesdale 85th, Midland 89th and in this list Co-operative Bank, last of all with a pay-out of just pounds 10,839.82. (A year ago it was 69th).

The best current rates on roll-over Tessas are around 7 per cent on variable-rate accounts, and are actually lower than they were earning a year ago, when the best rates ranged from 7.5 per cent to as high as 8 per cent (from Northern Rock). But an estimated 40 per cent of roll-over proceeds went into fixed-rate Tessas in 1996, reflecting the inevitable disappointment that investors in variable-rate Tessas felt over the virtual halving of interest rates payable on the first variable- rate Tessas taken out in 1991 by the time they matured.

The best fixed-rate Tessas currently on offer pay up to 7.5 per cent (from Sun Banking Corporation) for the next five years, which is much the same as they were offering a year ago.

But investors with maturing Tessas in 1997 may well be looking forward to a rise in interest rates over at least two, maybe three, of the next five years. If rates rise significantly they might well do better to roll over into a variable-rate Tessas in 1997 and keep their options open.

Virtually all providers will charge transfer penalties on savers who want to switch their Tessas in mid-stream.

Charges vary, but they can be as little as pounds 25-50 to get out of a variable- rate Tessas, while anyone trying to get out of a fixed-rate Tessa usually faces substantial penalties of up to 180 days lost interest.

This year, more than ever, it might be worth inquiring what the transfer charges are as well as the rates of interest on offer before tying the money up.