When considering investing in a PEP, it's easy to forget about charges. But, as Simon Read explains, this could be a costly mistake

CHARGES levied by PEP managers can make a real difference to your eventual gains. In fact, if the charges are too high, it could mean that your investment may never return its original value. If that sounds far- fetched, then consider that many PEP managers have initial charges as high as 5 per cent. This means pounds 300 lost from a pounds 6,000 investment.

If shares go through a dull patch, it could take some time for your investment to regain its original worth. In effect it needs to grow by 5 per cent to recover, and that's before considering any administration charges.

The main factor when deciding on a PEP should be your view of its likely performance. But charges are also important.

Now, more than ever, charges are to the fore. The weeks up to the end of the tax year on 5 April are the most popular time for buying PEPs, as people try to make the most of their allowances before the opportunity disappears. Accordingly, managers are offering discounts and special offers.

Nat West, for instance, has halved initial charges on eight of its unit trust PEPs. This could mean a saving of between pounds 118 and pounds 153.

Wesleyan Financial Services, a life insurer which has expanded into PEPs, has also slashed initial charges on its Wesleyan Growth unit trust from 4 to 3 per cent. The company levies a 1.5 per cent annual management charge on its product, which ranked 64th out of 136 funds in its sector in the year to February.

Foreign & Colonial is offering two for the price of one for those who take out an investment trust PEP with the group before the end of the tax year, and then another in the 1998/99 tax year. The pounds 50 initial charge on the second will be waived.

Fidelity, like many other managers, has chosen to go the discount route by offering 1 per cent off the initial charge on its investment trust PEP range.

There are plenty of other offers, and many low-cost PEP managers simply point out that they have no initial charges. Companies such as Legal & General, Virgin Direct and Fidelity have done away with up-front charges in the last two years. This has been highly successful; these companies have attracted much of the new PEP business, especially as many others still make an initial charge up to 5 per cent.

The low-cost providers have also pared annual management charges to the bone. Virgin Direct and Fidelity charge just 0.7 per cent a year, while Legal & General charges just 0.5 per cent. Most PEP managers make an annual charge of around 1.5 per cent.

The savings can be considerable if you choose a low-cost PEP. But is there a downside? Well, yes. The reason that companies such as Virgin Direct and Legal & General can afford to slash charges is because they've cut back on costs by cutting out fund management altogether.

Instead, they rely on funds that replicate average market performance. They do this by using tracker funds that simply buy all, or a representative sample, of the shares in a particular index, such as the FT-SE 100 or the All Share index. Many PEP managers have followed this route of no initial charges.

The average annual management charge for a PEP now stands at around 1.5 per cent. If any one is markedly more expensive than this, you should only really consider buying into their PEP if you think they can offer remarkably better investment returns than anyone else.

Also when looking at PEPs, check to see whether there are any exit charges. Some PEP managers cut their initial charges, only to slyly introduce exit charges. These penalise you if you take your cash out of their investment. M&G for instance is guilty of charging 4.5 per cent if you cash your PEP in before the year is out, although its charges drop year by year. Legal & General charges 5 per cent. Others simply charge a lump sum - Henderson, for example, charges pounds 20.

One final point to watch out for is the bid/ offer spread, the difference between the cost of buying and selling a PEP. For example, Royal & Sun Alliance is offering a low-cost tracker PEP with no initial charges and an annual management fee of just 0.3 per cent. But its bid/ offer spread is 5.5 per cent, which negates the price advantage on offer, compared to Legal & General, at least.

One way to cut the impact of charges is to buy your PEP through a discount shop. All advisers earn commission from the PEP provider every time they sell a plan. In order to offer a discount, the brokers have been splitting the commission with customers, which significantly brings down the charges.

The Independent has published a free `Guide to Making Your Investments Work for You'. The guide, by Steve Lodge, personal finance editor on `The Independent on Sunday', is sponsored by Wesleyan Financial Services. It is available by calling 0800 1379749. Or fill in the coupon on page 12.