Happy dilemma for investors

IT IS a pleasant thought - 2 million savers with thousands of pounds of maturing Tessa money in the new year worrying over the problem of deciding what to spend it on.

Note spend, not save. For all the hype and advertising exhorting you to reinvest Tessa money in another Tessa, personal equity plan or other savings product, Amanda Davidson at financial adviser Holden Meehan says savers should not automatically think they have to reinvest the money. There are no penalties involved for taking cash from a maturing Tessa. And there is a positive incentive to do something because interest on matured Tessas is taxable and is unlikely to match that on your old account or that on new Tessas on offer.

Once you have satiated any consuming frenzy, however, Ms Davidson recommends "logical housekeeping". That means paying off expensive loans that are charging you more in interest than you could be certain to get from an investment. The argument for reducing mortgages is more finely balanced, as explained on the facing page.

The obvious first choice for reinvestment is a new Tessa account, sometimes referred to as a Tessa 2. The banks and building societies are keen to hang on to maturing Tessa money. Many are prepared to offer a bonus if you "roll over" maturing money into a new Tessa offered by the same institution. The Halifax, for example, which claims to have a quarter of all Tessa savers, will pay a pounds 50 bonus to savers with maturing Halifax Tessas who reinvest in a Halifax Tessa 2.

You can roll over up to pounds 9,000 of the money you put into the first Tessa into a Tessa 2, but, importantly, not the interest earned - which could amount to as much as pounds 5,000.

Rates on new Tessas announced so far - typically 6 or 7 per cent - are not that exciting, although they should be seen in the context of low interest rates generally and low inflation. As well as Tessas offering fixed and variable rates of interest, there are others with interest that rises in fixed steps - say 5 per cent in year one, 6 per cent in year two and so on - and Tessas whose return is partly dependent on the performance of the stock market. Variable-rate Tessas are typically quoting interest rates that are up to 1 percentage point less than fixed rates.

One attraction of reinvesting in a building society Tessa 2 is that you may get a windfall if the society restructures or is taken over. The Halifax, which has already announced it is converting into a bank, says that its existing savers who reinvest in its Tessa 2 will remain eligible for free shares when the society joins the stock market, probably some time in 1997.

Tessas are a simple and secure choice for investment, offering tax-free interest with no risk to your capital. If you need to live off your savings, they can pay out their interest net of basic rate tax (net of the new 20 per cent savings tax after April). Even if you are not sure you want to save for the full five years, their net rates are often more attractive than other savings accounts, but do watch out for penalties for closing early.

If you are prepared to take more risks with your money - specifically the ups and downs of the stock market - you might consider a PEP, the other main tax-free vehicle for savers. A reason- able unit trust PEP investing in shares should outperform a Tessa over five years, as it has done in the past five years. But in the meantime, it might fall in value and will offer a lower income. A corporate bond PEP is something of a halfway house - it combines higher income - typically 7 per cent or more - with a fluctuating capital value. The Association of Unit Trusts and Investment Funds has produced a free fact sheet (telephone 0181 207 1361) looking at both Tessas and PEPs. The latter could be used as a home for the interest you cannot roll over into a new Tessa. As well as offering the potential for higher returns, PEPs also allow more flexibility for taking cash from your investment without upsetting its tax-free status. Next year, competition should drive PEP prices down further.

Ms Davidson also suggests looking at putting Tessa proceeds into your pension. You may well be able to get further tax relief at your highest rate of income tax on Tessa money you put into the pension through tax rules that permit "carrying" income or reliefs back or forward.

Finally, there is no rush to decide. Accounts do not mature until at least January. There will be plenty more offers in the Spring and you have six months from the maturity date to take advantage of the the ability to roll over a full pounds 9,000 into a Tessa 2. And with the stock market at an all-time high, savers should be in no hurry to pour money into it.