Put your trust in Peps

Many investors are missing out on the tax advantages of the personal equity plan. By Paul Slade
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Thousands of savers could be wasting tax by failing to shelter their unit trust savings within a tax-free Personal Equity Plan, according to industry figures out this week. A new survey from the Association of Unit Trusts and Investment Funds shows that the average unit trust investor's portfolio is worth only pounds 4,649, well within the limit which allows investors to invest up to pounds 6,000 a year in a PEP.

But while 28 per cent had both bought a unit trust PEP and bought unit trusts directly, presumably because they had already reached their pounds 6,000 PEP limit, a further 13 per cent of recent unit trust buyers bought their trusts direct, rather than doing so through a PEP, which suggests that many people are still needlessly paying income and capital gains tax on their savings.

PEPs have been around since 1987 but investors have been buying unit trusts and investments for a lot longer, and many may not be aware of the current rules. Your main PEP can hold up to pounds 6,000, which you can top up with a single-company PEP to the maximum of pounds 3,000. Single-company PEPs, as the name suggests, can hold shares in only one company, and are often used as part of an employee share ownership scheme.

The PEP itself is not an investment plan, but puts your money in unit trusts or investment trusts, giving you access to a wide range of companies' shares. Some PEPs will put your money into just one of the fund manager's unit trusts, such as a broadly based UK equities fund, while others spread your money across a handful of different funds. If your investment does well, the shares' growing value gives you capital growth, while the dividends which the shares pay out can be taken as income.

Some PEPs put your money not into unit trusts, but into investment trusts. Both these products allow you to spread your investment across a wide range of companies and markets around the world, but they do have some different characteristics.

One key difference is that investment trusts are allowed to borrow money to boost their investments, while unit trusts are not. This process,

known as gearing, should allow an investment trust to outperform a comparable unit trust when the stock market is rising. But gearing exaggerates not only your profits but also your losses, which can make investment trusts more volatile.

Tax is not the only advantage of buying trusts in PEP form. New entrants to the PEPs market, such as Richard Branson's Virgin Group, have also driven charges down, which means you can often pay just 3 per cent initial charge on unit trusts bought through a PEP, but 5 per cent on the same trusts from the same management group if you buy your units direct.

PEPs are also exempt from capital gains tax. Many savers will find the PEP's capital gains tax exemption irrelevant in the plan's early years, as you pay CGT only when your annual profits from investments reach pounds 6,000. But this relief does become worthwhile later. The only other significant downside of PEPs is that they may weight your portfolio unduly towards UK and European stocks.

There are two types of unit trust or investment trust you can include in your PEP, known as qualifying and non-qualifying trusts. Qualifying trusts, which must account for at least pounds 4,500 of your pounds 6,000 main PEP, are those with half or more of their assets in the UK or other European Union countries. Non-qualifying trusts, which are free to invest elsewhere, can account for only pounds 1,500 of your pounds 6,000 plan.

So, if you are convinced that returns from outside the EU are likely to significantly outstrip those in Europe, you might be prepared to forgo your tax break in order to invest as fully as possible in those markets. Higher returns generally carry the price of higher risk, however, and this strategy will not be suitable for all investors.

The fact that you can buy a new PEP every year, and that both husband and wife can invest up to pounds 9,000 a year each, means that couples with PEP portfolios of pounds 100,000 or more are not uncommon.

Few fund managers would recommend having a portfolio of that size quite so heavily weighted towards the UK market as most PEPs are, particularly as we approach a general election and probable change of government.

Barry Bateman, president of Fidelity Investments Europe, says the vast majority of the group's PEP clients have almost all their money in the UK, and that the pounds 1,500 non-qualifying allowance is largely ignored.

He says: "It's not that we're not optimistic about the UK, but generally diversification is a sensible investment approach. People's PEP portfolios may well represent the vast majority of their equity investments, and if it's all skewed towards the UK, that doesn't seem to be particularly prudent. If you've got a pounds 100,000 portfolio, then in an ideal world you'd have pounds 25,000 of that overseas."

Fidelity is hoping to tackle this problem with the launch of its new triple-performance PEP. This plan will put 50 per cent of investors' money into the company's UK special situations trust, 25 per cent into its European trust, 25 per cent into its European trust and 25 per cent into its South-east Asia trust. All these three funds have grown at twice the rate of their respective stock market indices since launch.

The Autif survey also suggests that equity investments through unit trusts are no longer only for the rich. Before PEPs made their debut in 1987, the average unit trust holding was about pounds 12,000 to pounds 15,000, three times today's level. The survey also shows that 70 per cent of unit trust investors are either basic- or lower-rate taxpayers, earning less than pounds 24,300 a year.

Despite the stock market's record performance in 1995, unit trust PEP sales fell from 1994's total of pounds 3.9bn to just pounds 3.1bn. Autif believes this is because there is a built-in time lag between people observing strong stock market performance and actually buying a PEP or some other equity product. Sales in the final quarter of 1995, up to pounds 802m from pounds 698m the previous quarter, would seem to support this view. PEPs accounted for 77 per cent of all retail unit trust sales in December 1995.

Part of the recovery is due to the growing awareness of the recovery in the stock market. But inflows have been boosted by the emergence of two new products, index tracker funds and corporate bond PEPs. Index tracker PEPs, unlike actively managed funds, do not rely on the fund manager's skill at stock-picking. Instead, the fund buys either a stake in every company represented by a particular stock market index, such as the FT- SE, or just enough stocks to mirror accurately the index's performance.

Many investors like these funds because they are easy to understand and you can keep track of your investment simply by following the FT-SE. All but about 20 per cent of actively managed funds underperform the index in any case, which means investors in the remaining 80 per cent of actively managed funds would be better off with a tracker.

The corporate bond PEP is for those investors whose priority is immediate high income rather than capital growth. These plans do not buy shares, but the bonds which companies use to borrow money from investors. Savers put pounds 478m into corporate bond PEPs during 1995.


1.The cheapest and most tax-efficient way to invest in a unit trust or an investment trust is in the form of a personal equity plan.

2. Unlike unit trust and investment trust holdings the interest on assets in a PERP is free of income tax, and capital gains are exempt from CGT.

3. PEPs make good substitutes for a pension plan, but can be sold at any time and the gains are still tax-free, unlike a Tessa.

4. Investors can put up to pounds 6,000 in each tax year into a personal equity plan investing in a unit trust, investment trust or selected shares.

5. They can also put up to pounds 3,000 more each year into a single-company PEP investing literally in the shares of one company, often as part of an employee share-ownership scheme.

6. Since last July a PEP can be invested in corporate bonds, fixed interest securities and loan stocks issued by UK and EU companies as well as UK government securities to produce a high-income investment.

7. Three quarters of each PEP must be invested in trusts with at least half their assets in the UK or other EU countries. The balance can be invested elsewhere, in the US or Japan.

8. Personal equity plans are mostly run by investment managers or stockbrokers but it is possible to have a self-select PEP and choose the assets yourself.

9. PEP managers can charge an initial fee to set up the PEP, an annual management charge and a withdrawal charge, but as a result of competition charges are falling and PEPs are often cheaper than ordinary unit trusts.

10.You can invest in a PEP with a lump sum or a regular savings contribution.

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