FOOL SCHOOL
TESSA-Only ISAs

March 3, 2004

Do you remember TESSA, the Tax Exempt Special Savings Account? These lasted for 5 years. You were allowed to invest up £9,000 over this time, subject to a maximum of £3,000 in the first year and £1,800 in subsequent years. But you got all your interest tax-free. The last day you could open one was 5 April 1999 so, although you can't open a new one, plenty of us still have one that is yet to mature.

When the TESSA matures, 5 years to the day after you took it out, you have the option of reinvesting the capital you put in (not the interest you've earned) into what is known as a TESSA-Only ISA. The amount you reinvest doesn't count as part of your ISA contributions for that year and you have six months from when your TESSA matures to decide what to do.

The rates for these TESSA-Only ISAs are often a little bit less than those for cash ISAs. The principles for choosing a TESSA-Only ISA are exactly the same as those for an ordinary cash ISA namely go for a high rate, keep one eye on it and be prepared to move your cash should the rate you're being offered become less attractive. In theory you are entitled to reinvest the capital element into a cash mini ISA or the cash component of your maxi ISA. However, in practice many companies don't let you do this (they are not obliged to) and will insist you open up a TESSA-Only ISA so that they have more flexibility with the interest rates they can pay.

Watch Out For Variants

Be aware that there are some curious variants of the TESSA-Only ISA that might catch your eye because they offer interest rates that are linked to the stock market rather than just a bog-standard percentage rate. In these instances, returns are linked to the performance of one or more major stock markets and you'll be promised, say, 75% of the growth over a five-year period with no risk to your capital, as long as you agree to lock your money in for that period. The provider, of course, gets the remaining 25% (there's no such thing as a free lunch). Whilst the capital guarantee has its attractions, handing over 25% of your gains is a hefty price to pay for the privilege.

Find out more in our Cash ISA centre.