Don't fret over the fate of PEPs

TAX-FREE SAVING

Over the 10 years that they have been available, personal equity plans (PEPs) have become a popular way of investing in the stock market. In 1999, along with Tessas, they are due to be superseded by Individual Savings Accounts (ISAs).

The introduction of ISAs was announced by the Chancellor of the Exchequer, Gordon Brown, in his July Budget. The Government is now consulting with the savings industry on how ISAs should be structured. Early next year it hopes to publish a White Paper that will give details.

So far we know very little about how ISAs will work. Will PEPs be converted fully into ISAs? Will there be a cap on the amount that can be converted? Will savings have be locked into the new accounts for a minimum period? We don't know yet.

The Personal Investment Authority (PIA), which regulates the savings industry, has warned that PEPs should not be treated as being in a fire sale, and investors should not be panicked into buying quickly them for fear of missing out.

Since their introduction in 1987, PEPs have attracted billions of pounds of savings from around 3 million investors. No wonder; they offer the saver a way of investing in shares free of all personal taxes. All dividends and income earned by a PEP are free of income tax and there is no capital gains tax liability on profits from increasing share prices.

You can put up to pounds 6,000 a year into a general PEP, plus another pounds 3,000 a year in a single company PEP. Money can be invested in a lump sum or through regular savings, with no time limit on how long it has to stay there.

PEPs are not investments in themselves, but wrappers for other investments. A general PEP normally holds a range of shares and/or bonds, most commonly in a type of investment fund called a unit trust.

Most PEPs are invested in unit trusts and, to a lesser extent, investment trusts. This way the investor buys a stake in a ready made portfolio, reducing the risks involved in individual shares. Investments have to be over 50 per cent invested in the UK or any of the European Union stock markets. Investment in other overseas stocks and shares is limited to pounds 1,500.

There is another type of PEP - a "self-select" PEP - where you can pick individual shares for inclusion in a plan. Run mainly by stock brokers, these are only for sophisticated investors.

Charges vary between the different investment houses. But just as important as charges is performance, and this will depend on the skills of the investment manager.

The type of PEP chosen depends on the investor's needs. There are dozens of corporate bond and higher-income PEPs for those who want a tax-free income. But the higher the income the less likelihood there will be of significant capital appreciation.

If long-term growth is the aim, there are hundreds of funds to choose from. Much depends on the risks the investor is ready to take. The greater the risk, the more the potential gain - or loss. The most cautious investor should look at what are called index-linked or balanced funds.

If you are prepared to take more risks, then there is a wide choice of funds investing in different sectors such as financial and high-technology stocks. The ethical and environmental investor is catered for, with funds that can perform just as well as conventional instruments.

An independent financial adviser will be able to help you sort through the maze of funds available and find the one that fits in with your investment criteria.

Many are cautious about investing now with the stock market at very high levels. But in the long term - five years or more - equities have always outperformed other conventional investments. Investing on a regular monthly basis will iron out any peaks and troughs in the market.

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