A place in the sun for society windfalls

READERS' LIVES: The case for putting free shares into a PEP... life insurance investment plans ... boosting a pension. Your financial queries answered
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I am due to receive three lots of free building society shares and want information on putting them in a PEP. Once set up, can further shares be added to the PEP? How are dividends dealt with?

SM, London

Because you are paying nothing for these windfall shares they do not count towards the normal PEP investment limits as long as you PEP them within 42 days of the shares being issued. In other words, you'll be able to invest a further pounds 6,000 (or pounds 3,000 with single-company PEPs) on top of the free shares.

So the first deadline - for those receiving Alliance & Leicester shares - is the end of May. If you transfer windfall shares into a PEP after the first six weeks they will count towards the PEP investment limits.

Most PEPs - but not single-company versions - will allow you to add your subsequent batches of windfall shares - again without using up any of your PEP allowance. Meanwhile, you should also be able to add cash during the year to make your other investments.

Dividends are initially paid directly into the PEP and the PEP manager reclaims the tax credit. This money can be put into further investments within the PEP and also comes on top of the pounds 6,000 and pounds 3,000 limits. Alternatively, you may wish to take the cash. You'll need to check the rules and charges set by individual PEP managers.

As with all PEPs, check the charges to make sure they don't come to more than the tax reclaimed. The only reason for considering putting your shares in a PEP is to save money.

The Share Centre (0800 800008) is one of many PEP providers with a low- cost plan aimed at building society customers. Its PEP has a quarterly charge of 0.15 per cent of the value of the shares, subject to a minimum of pounds 7.50. That's a minimum of pounds 30 a year. So if you're a basic-rate taxpayer, your shares will need to pay dividends of more than pounds 120 a year plus a pounds 30 (income) tax credit before it becomes worth while putting them in a PEP. That could be on the high side for the number of shares many people will receive. In practice, even low-cost PEPs will not be worth while for many people.

A PEP also saves you capital gains tax while if you sell your building society shares outside a PEP the entire proceeds will be subject to the tax. However, most investors don't make enough gains to pay capital gains tax. The first pounds 6,500 of gains (in the current tax year) are tax-free. But with the three lots of shares you are due to get, a PEP may be worth while, depending on their value. A Labour government could, of course, tighten up the rules.

Many PEP companies are announcing special deals - watch out for ads and our own editorial comment. But remember you need do nothing until at least May - assuming you are an Alliance & Leicester shareholder.

With some PEPs, the shares will be sold and the money reinvested in unit or investment trusts. This may save you the dealing costs of selling the shares yourself - but you need to decide whether you really want to invest the money or put it on deposit in a building society.

Investment manager Johnson Fry has a free guide to the PEP options for windfall shares. Call 0171 451 1199.

I've been paying pounds 10 a month into the Target Property Investment Plan since 1973. The policy is due to mature in another seven years when I am 65. The projected maturity value seems to be steadily declining. I've received an explanation but don't really understand it. Should I surrender the policy and put the proceeds into a PEP?

EM, Kent

As a general rule, most people should avoid life insurance-based investment plans. But once you have started paying into such a plan, early cash-in values can be poor - and you are then faced with the difficult decision of whether to cut your losses.

Unfortunately, projected maturity values offer little guidance as to what a policy will actually be worth when it reaches the end of its life. Your projection of pounds 15,576 back in 1973 was down to pounds 9,670 (assuming 10 per cent growth) or pounds 6,450 (assuming 5 per cent growth) by May 1995. Eighteen months later it had fallen further to pounds 8,550 or as little as pounds 6,160. As long as your investment performance continues to fail to keep pace with the growth rates used for projections, the projected maturity values will continue to fall.

Projections use standard growth rates laid down by the financial watchdogs. They are of most use before you take out an investment because they let you compare the effect of different companies' charging structures.

If you decide to cash in now, you may not even get the current value of your investment - the "unit" value - because "units shown may be subject to a deduction in accordance with policy conditions", as the company puts it. But you could ask Hill Samuel for a cash-in value to see how much money you would have to invest in a PEP or other investment (such as a tax-efficient pension plan). If you cash in now remember that you'll also be saving another seven years of monthly premiums.

Should I make additional voluntary contributions to boost my employer's pension? Or would I be better off putting the money into a PEP?

JM, Cambridge

This is a very pertinent question - and one that is being asked by more and more people. Conventional wisdom is that the best way to save for a retirement is to put your money into a pension plan. But more and more advisers are suggesting PEPs, too - often as a back-up for someone already in a pension scheme.

Here are the main differences to consider. There is no tax to pay on investments within a PEP or a pension fund. But pensions have the added advantage that you get tax relief on your contributions. The value of your contributions gets an immediate boost. Money put into PEPs does not attract upfront tax relief. However, pensions are taxed when they are paid out, whereas you can draw an income from a PEP tax-free.

PEPs are more flexible than pensions. You can cash in your money whenever you like and do with it what you like - taking a lump sum or drawing an income. By contrast you can't get at your pension fund money until you reach a certain age (which depends on the type of scheme and the rules of the scheme). And there are all sorts of rules about how you can convert the fund into a pension income. Additional voluntary contributions cannot be taken as a lump sum on retirement.

On average, you are likely to lose less of your money in charges with a PEP than with a pension. But with a PEP you need to be sure that you won't be tempted to cash it in before retirement - if that is what the money is earmarked for.

Furthermore, if you were ever to seek state benefits before you retire or get into financial difficulties, funds in PEPs will count as part of your capital, whereas pension savings do not.

The best advice is probably to talk to a competent financial adviser as to what is the best option for you.

Write to Steve Lodge, Independent on Sunday, 1 Canada Square, Canary Wharf, London E14 5DL, and include a telephone number. Do not enclose SAEs or any documents that you wish to be returned. We cannot give personal replies or guarantee to answer every letter we receive. We accept no legal responsibility for any advice given.

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