Tessa, PEP or ISA?

More than 17 million Brits now hold an Individual Savings Account (ISA) which means that many investors now hold sizeable tax free portfolios.

The ISA was introduced by the Labour Government in 1997 as a replacement for Personal Equity Plans (PEPs)which were introduced by ex-Chancellor of the Exchequer, Nigel Lawson, as a way to encourage people to invest in the stock market.

The PEP focused on investing in UK-listed companies and the maximum investment was just £2,400 per calendar year. The ISA on the other hand has different options for investors, from cash to stocks and shares and the investment limits are much higher at £3,000 for a mini ISA and £7,000 for a maxi ISA.

The rules surrounding ISAs are about to change with the 2008 budget, and will hopefully be much more simple for investors. After the 6 April 2008 there will no longer be a mini/maxi distinction and instead there will just be a cash ISA and a stocks and shares ISA option. The investment limits are also going to be increased, to £3,600 for a cash ISA and up to £7,200 for a stocks and shares ISA.

Other changes, such as the ability to roll a cash ISA into a stocks and shares ISA, are also set to be introduced.

The main similarity however, between a PEP and ISA, and arguably the most attractive for investors is that the money invested is not subject to income tax or capital gains tax (CGT).

What is a TESSA?

The TESSA, Tax-Exempt Savings Account, was introduced in 1990 by the then Chancellor, John Major, and they were designed to balance the equity-orientated nature of a PEP by allowing investors to invest cash in a TESSA-designated deposit or share account.

However, neither the PEP or the TESSA were going to survive the change to a Labour Government in 1997, but because of their popularity with investors, the ISA was introduced as a replacement that took into account the attractive elements of both its predecessors.

Since April 1999 it has been impossible to open a new PEP or TESSA, however, existing accounts could continue. TESSAs had a fixed life on five years and upon maturity could either be cancelled or rolled into an ISA, and as of April 2008 all existing PEPs will be automatically rolled into a stocks and shares ISA without affecting your investment limit for the 2008/09 tax year.

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How to Invest

It is really easy to invest in an ISA and save your money tax-free. Most highstreet banks and building societies offer competitive ISAs as well as other investment houses.

Depending on how risky you want to be with your money with ultimately be the deciding factor when it comes to which type of ISA you choose. Investing in a cash ISA doesn't carry with it much risk, but the interest paid on the amount invested is lower than that paid if you opt to invest in stocks and shares. Plus the investment limit is lower if you choose to invest in cash, so it is important to take all of these factors into consideration.

When investing in stocks and shares, you must be prepared to lose money simply because the account follows the stock market and as we all know, these prices can go down as well as up. However, on the plus side, the interest rates offered for this type of ISA are much more competitive and the investment limit is much higher.

Also if you opt for what is currently known as a maxi ISA, you have the option of investing up to £3,000 in cash anyway, with the remaining £4,000 in stocks and shares.

Remember, if you are unsure about what type of ISA would be best for you it is best to seek independent financial advise from an Independent Financial Adviser (IFA).

See also: Can My Friend Pay His Cheque into My Account? for more on this topic.

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