Tessa's troubles

Thousands of us succumbed to the riot of advertising and opened a tax-exempt special savings account (Tessa) before they shut for new business in April. If you were one of these canny savers, you no doubt congratulated yourself on a neatly timed investment - five years of competitive interest rates, and tax-free to boot.

If you had pounds 3,000 to save, you probably looked hard at Skipton Building Society's chart-topping 7.4 per cent (as of 1 March). Many other accounts were paying around 6.5 to 7 per cent.

If you have followed the movement on rates since then, you have probably been disappointed. A recent survey of 30 top Tessa providers carried out by independent statistics provider Moneyfacts shows most of those enticing interest rates now lag behind their new ISA (individual savings account) counterparts.

Moneyfacts found 27 of the 30 institutions are paying less on Tessas - by as much as 2.35 per cent.

Philip Telford at the Consumers' Association says: "Banks and building societies are following a classic ploy - counting on the inertia of most account holders to suffer in silence or simply not to notice as the headline rates of that account are allowed gradually to lapse once it's become obsolete. It's not illegal, but it's not exactly fair play."

But if you decide to transfer to another provider with better rates there are often punitive penalties.

Adrian Korsner from London took out a follow-on Tessa with Northern Rock about three years ago when it was paying 7.5 per cent, one of the best rates at the time. He recently received notification that his account is now paying 4.5 per cent. He phoned to find out whether he could transfer into one of the other Northern Rock Tessas (both paying better rates) but was told he could not because they are fixed-rate products. If he transferred to another provider he would be charged pounds 30.

"I think it's a deplorable situation to lock me into such a low-interest account, when Tessas were sold on the premise of earning more interest by not paying tax," he said.

Northern Rock defended its position saying: "It's important that investors look at the overall return over the whole investment period." It points out the 4.5 per cent rate now applies to the first three years of the Tessa. In year four it rises to 5.85 and in year five to 6.1 per cent. Still, that now averages out at 5.03 per cent a year over the five-year term; by contrast, the Rock's cash ISA is paying 5.75 per cent.

Moreover, if your Tessa is paying less than 4.8 per cent - there are six included in the Moneyfacts survey - you would actually be better off paying tax on your savings within a top-paying no-notice account.

In this context, Northern Rock said that if Mr Korsner was prepared to sacrifice his tax-free status, he could switch, free of charge, into their Base Rate Tracker, that is currently paying 6 per cent (which amounts to 4.8 per cent gross).

Why the differential between Tessa and ISA rates? "They are different types of products with different terms and conditions," a Northern Rock spokesman said. But there's nothing so very different from the point of view of the average consumer. Surely it's the same type of low-risk, high- interest tax-free deposit account, albeit with different investment parameters? (You can only put pounds 1,000 per year into a cash ISA after this first year when the limit is pounds 3,000; you can hold your ISA indefinitely rather than for a maximum of five years.)

Even if you are not penalised too severely for taking your savings out of a Tessa, don't expect to be able to slot it into the highest paying alternative. Many Tessas paying acceptable rates of around 6 per cent do not accept transferred accounts. The Ipswich BS is one of the few places that does welcome Tessa transfers.

n Contacts: Coventry BS, 0845-766 5522; First Direct, 0800 242424; Furness BS, 0800 220568; Ipswich BS, 01473 211021; Julian Hodge Bank, 01222 220800; HSBC, 0800 180180; Norwich & Peterborough BS, 0800 883322.

SHOULD I MOVE MY ACCOUNT?

Hassle: is the rate really that bad? Although many providers are paying Tessa rates below their ISA rates, the odd half percentage point may not be worth worrying about, even if you can switch without penalties.

Newness: is your account a recent one? Those who leapt in over the past few months of the tax year face five years of dwindling returns as providers focus their attention on accounts where they can attract new business. They might be better off transferring either to a more attractive Tessa (see box below for top rates accepting transfers) or to a taxable account.

Maturity: are the five years nearly up? If so, it's probably worth hanging on until the term is up and then rolling it over into a Tessa- only ISA. These are paying very competitive rates.

How much is the penalty? Some charge only a few days' or a week's interest, which doesn't amount to much. By comparison, if you lose 180 days' interest at 5.75 per cent on pounds 3,000, it will cost you pounds 86. Birmingham Midshires has a firm grip on its savers.

FLEXIBLE DEALS

A selection of providers offering good rates and accepting transfers

First and follow-on Tessas

First Direct 6%

Furness BS 6.1%

Julian Hodge Bank 6.25%

HSBC 6%

Norwich & Peterborough

BS (first Tessas only) 6.25%