Tessa poised for final bow

Time is running out if you want a slice of the tax breaks on offer but consider your options carefully

THIS weekend is the last chance to grab some tax breaks which bite the dust at midnight tomorrow. Organisations as diverse as the Abbey National, Marks & Spencer, Virgin and First Direct are all keeping their lines open in the hope you will call and place some money in their care.

In less than 48 hours the heyday of Tax Exempt Special Savings Accounts (Tessas) and Personal Equity Plans (Peps) will be over. But before dashing out to their closing down sales, investors should think seriously about what a Tessa or Pep might bring them, and what they might lose, if anything, by letting the deadline pass unheeded. They also need to reflect on the relative merits and disadvantages which their successor, the new Individual Savings Account (Isa) will bring to the investment equation. Only by understanding how the different tax breaks fit together can you be sure of making the right kind of investment. The simplest and most straightforward is the Tessa, which is essentially a bank or building society deposit account paying interest tax free, if the investment is left untouched for five years. You can invest #3000 in the first year of a Tessa, and then #1800 thereafter up to a maximum #9000. Interest can be withdrawn net of tax, provided the capital and gross tax is left intact. Savers wishing to maximise the tax breaks on deposits can open a Tessa this weekend, and still shelter further cash from tax in an ISA after Monday. Personal Equity Plans are designed to shelter investments in UK and European stocks and shares from capital gains tax and income tax. It is important that investors understand that a Pep is not an investment in itself but simply a tax-free wrapper around an equity investment. You should never invest for a tax break alone. So if you have sufficient funds to make an equity investment a wise choice, then a Pep can be useful, otherwise it can prove a foolhardy venture. Historically, shares have outperformed all other kinds of investments over a period of between five and 10 years, but they can be volatile over shorter time horizons. This means that if markets dip, as they always do from time to time, you may not get all your money if you are forced to cash in your shares at a low point. But potential investors also need to understand the nature of the tax break itself to judge how much a Pep might be worth in their particular circumstances. Profits from shares are taxed in two ways. Firstly they are liable to capital gains tax on the increase in their value. This means that from April any profits you realise in a year above your individual #7100 allowance will be taxed at either 20% or 40% tax, depending on your highest tax rate. Or to put it another way, a husband and wife can already take profits from shares worth #14,200 in a year, without paying any tax anyway. Equities also receive income in the form of regular dividends paid to the shares, which are liable to income tax at your highest rate. A Pep will provide some limited protection against this income tax, in that the dividends are paid net of standard rate tax, but the Pep can reclaim a 10p refund. So, if you are planning to invest in equities and your tax affairs are such that they would benefit from a Pep, then now is the time to act. Certainly they can be invaluable for long-term financial planning purposes, such as towards retirement or educational purposes, where you could find yourself cashing in large chunks of investments all at once, and incurring tax bills you had not previously envisaged. Peps offer a more generous tax shelter compared with the new Isa. You can invest #6000 this weekend in a unit or investment trust or general managed Pep, investing in a basket of shares, plus an additional #3000 in a single-company Pep investing in the shares of just one firm. Furthermore, the fund can, for the time being at least, grow freely without an artificial ceiling being imposed. By contrast, Isas are a hybrid Pep and Tessa which are at the same time both more flexible yet more restricting than the umbrellas they replace. The maximum annual investment is lower at #5000 whereas Tessas and Peps combined allowed #12,000 to be saved each year tax-free. As an interim measure in the first year, investors can exploit a #7000 overall annual allowance. Within that overall allowance investors can place #1000 pounds in a Tessa-type deposit account, although during the first year again this limit has been raised to #3000. A further #1000 pounds can be invested in life assurance, and the balance inequities and bonds either directly or through managed funds. To complicate matters further, investors can pick between a maxi Isa and a mini Isa. With a mini Isa you place each separate component of the investment with a different company. For example you might put money on deposit with a building society, but want a fund manager or stock broker to oversee your equity investment. However, a maxi Isa allows you to hand your entire allowance for the year to one company. In this case you might choose not to have any deposit or life assurance element at all, but to invest the entire tax break in equities. But the main advantage of an Isa over a Tessa is that there is no five-year time restriction. You can withdraw your money whenever you like.

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