Peter Shipp discusses the options available to investors with Tessas wishing to transfer their capital into Isas
Poor Tessa was a frail child. Medical procedures were less advanced in those days and Tessa had to be kept in isolation for a full five years away from those infectious germs that would have been her downfall had she been allowed out. If she did escape, she would certainly have fallen victim to at least one of those ailments waiting to sap her strength.
Fortunately, medical advances allow Tessa's younger cousin Isa to do many of the things that Tessa was prevented from doing in her heyday.
The most obvious disadvantage of the old Tessa scheme was that you had to lock your cash savings up for five years in order to enjoy the benefit of tax-free interest. Any withdrawal (other than certain interest) rendered the Tessa void and blew the tax-free status of the account. After the five years, the investor could have rolled the savings into a follow-up Tessa, thereby enjoying further tax-free interest in return for accepting a lock-in for another five years.
Although the ability to open new Tessa accounts (including follow-up Tessas) was withdrawn in April 1999, the ability to maintain such savings in a tax-free environment was enshrined in the new Isa rules. These allow transfers of Tessa capital (the amount actually put into the account over the five years but excluding any interest) within six months of maturity into a cash Isa, without counting against that year's annual subscription limit.
The Tessa lock-in was a disadvantage to someone who might have wanted to have their cash savings readily available for an unexpected rainy day. While this may have discouraged a few people, the latest available Inland Revenue statistics (September 2000) show £28.9bn still invested in Tessas, of which £18.5bn was in follow-up accounts.
The cash Isa provides the welcome flexibility that withdrawals can be made without jeopardising the tax-free interest, although the amount(s) withdrawn may not be able to be replaced. Furthermore, the cash Isa is not restricted to the deposit account, although about 98% are held in that format. It can also be used to hold units in money market funds or certain National Savings securities.
Some industry figures predict that some £4bn of Tessas will mature this year, providing an opportunity for intermediaries to guide savers into what will be for many of them the 'new' Isa era. There is still confusion about what exactly an investor can do with their mature Tessa capital.
Let us consider the case of Fred Jones who has a Tessa with the Trumpton Building Society. Within the Tessa rules, Jones has contributed as much as he could afford each year, amounting to a total contribution of £7,800 over the five years. His account matured on 9 July 2001 with a balance of £8,900, including £1,100 gross interest).
On 10 July, the Trumpton changed his account to be a normal share account earning net interest of 4%, pending his further instructions. They have also sent him details of their Tessa-only Isa (6% gross) together with a pre-printed application form for him to sign. Perhaps Jones will just sign the form, assuming that he has no other option. Hopefully he may seek advice before he takes that step. What advice should we give Jones, even if he has taken out a Tessa-only Isa with the Trumpton?
The Isa rules allow the Tessa capital, but not the interest, to be subscribed to any type of cash Isa. I say the capital can be subscribed because although the Tessa capital does not count against the subscription limits for the year, it can only be transferred into a cash Isa if the investor completes a valid application including all the necessary declarations.
While the age limit will not be an issue, because the saver must have been over 18 to have held a Tessa, the residency status may be. A Tessa saver now living in the Channel Islands would not be able to transfer capital to an Isa because they would not be able to make the residency declaration.
The various options are shown in the table to the left. Where investors have a cash Isa but have made no subscription to it in the current year, this shows that they can make a Tessa-only subscription to that Isa, leaving them free to make other mini or maxi subscriptions as appropriate later in the year. Alternatively, should they find a better interest rate available to them as a mini or (less likely) maxi cash component, the chart shows where they could take advantage of these.
The Tessa-only was a last minute addition to the Isa rules, introduced primarily to accommodate the investor with a maxi Isa that has no cash component. Such an investor would otherwise have nowhere to put their Tessa capital because the mini/maxi rules would prevent their opening a mini cash Isa.
However, notwithstanding the reason why the Tessa-only Isa was introduced, investors can use that route for their mature Tessa capital even if they have a cash Isa already in place.
This gives Fred Jones a great deal of flexibility. If he is happy with the Trumpton offer, he can just complete the application for a Tessa-only Isa with them and collect his 6% interest. If the Greendale Building Society Tessa-only product (at 6.95% gross) looks more attractive, he can take his Trumpton maturity certificate to Greendale and put his £7,800 there.
However, a new provider, the Nautical Bank, is offering cash mini Isas paying 7.1% gross so Jones decides to open his Isa with them. He wants to place all the £8,900 proceeds of his Tessa into the Isa, which he does by subscribing £1,100 as a normal subscription plus a transfer of £7,800 Tessa capital.
Had Jones chosen the Greendale Tessa-only route, he would have had to find another home for the £1,100 interest because nothing other than Tessa capital can be put into a Tessa-only Isa.
The investor always has the right to transfer the Isa to another manager and, at the point of transfer, the old manager notifies the new manager whether there has been any subscription in the current tax year. After the tax year in which the Tessa capital was transferred, this is just another cash Isa to which no subscription has been made in the current year.
We must ensure that Jones understands that he is not locked in to Trumpton as his provider. Even if he has already signed up to transfer into their Tessa-only Isa, he can still transfer that Isa to another manager. If Nautical Bank does not offer a Tessa-only facility (unlikely but possible), he could wait until the next 6 April and then arrange a transfer of what by then will be just a cash Isa into Nautical's new product.
While the transfer of Tessa capital into an Isa represents a one-off opportunity to put up to £9,000 into the tax-free wrapper on top of the annual subscription limits, does the investor have a further £7,000 to subscribe from elsewhere this year? If not, is it appropriate to put all the Tessa money into the cash component?
The rules do not insist that all the Tessa capital follows this route. If I only have £2,000 available for new savings this tax year, I could open a maxi Isa and subscribe £5,000 of my Tessa capital as a normal cash subscription to the stocks and shares component, leaving the balance of up to £4,000 to be made as a transfer of Tessa capital.
There are many questions to be asked. Like almost everything in life, things are more complicated than they seem or, perhaps more positively, there may be more options available to Jones than first seemed the case. Looking to the future, PIMA is unconvinced that investors should be forced to put their Tessa capital into the cash component of an Isa.
Surely with that amount of cash, an investor should be able to choose to direct some or all of it into the stocks and shares component where exposure to stock markets, perhaps through a growth fund, could be expected to enhance the capital value over time better than a deposit account. This is one of the questions currently being considered in discussions on the future development of the Isa.
The ability to open new Tessa accounts ended in April 1999.
The Tessa lock-in was a disadvantage for people wanting instant access to finances.
With cash ISAs, withdrawals can be made without jeopardising the tax-free interest.
Joined as head of strategy, multi asset, in June
Group income protection
Nine in 10 do not have income protection
Set to become part of Single Financial Guidance Body