Your Money: Windfall Special - The PEP dilemma

A personal equity plan can be a good place for the shares, but there are snags, says Abigail Montrose
One of the most tax-efficient ways to hold shares is in a personal equity plan, or PEP. If you hold your shares wrapped in a PEP you will not have to pay any tax on money you make from them.

But there are charges attached to PEPs, which can outweigh the tax benefits. So you need to think carefully before taking the PEP route. If you are not a taxpayer and are likely to remain that way, there are no tax advantages in PEPing your shares.

If you are receiving windfall shares but have no plans to invest in any other shares or investments that can be put in a PEP, you need to look closely at the charges to see if a PEP will be worthwhile.

A basic-rate taxpayer with pounds 1,500-worth of shares yielding the average dividend of 4 per cent would earn pounds 60 a year. If the shares are not in a PEP, pounds 12 of that dividend would go in tax, but the charges on the PEP could well be more than that.

Even if the basic-rate taxpayer had pounds 4,500 worth of shares yielding an average of 4 per cent, the PEP would save them only pounds 36 a year in tax. The annual charges on the PEP may not be much less than that, says Ian Millward, investment marketing manager at Chase de Vere, independent financial advisers. "For many investors any tax saving will be negligible and they may decide it's not worth the hassle of putting their windfall shares in a PEP," he adds.

It makes sense to opt for a PEP if you intend to keep your shares for several years. As time goes by, the size of your investment and dividends will grow and the tax benefits of the PEP will become more apparent.

When Abbey National floated on the stock market in July 1989, the shares were valued at 130p. Now they are trading at around 900p, which means that investors who did not PEP their shares will have paid tax on all the dividends and some may even have to pay capital gains tax (CGT) when they finally sell up.

You may want to set up a PEP with your windfall shares and use them as the start of an investment portfolio. If you opt for a self-select PEP, you can add other investments to it later. That could be other shares or other investments such as unit or investment trusts.

If you have already started a 1997-98 PEP, you may want to add your windfall shares to increase this year's PEP allowance. You can invest no more than pounds 3,000 a year in a single company PEP, but you can put pounds 6,000 in a general PEP which holds different shares. But so long as you PEP windfall shares within 42 days of their first day's trading, the shares do not count towards your annual PEP allowance.

The Halifax will operate a single-company PEP, and the other demutualising building societies may decide to follow its example. The Halifax's single company PEP has an annual management fee of 0.5 per cent plus VAT, and the minimum fee is pounds 10. You would be hard pushed to find a cheaper single- company PEP deal.

If you have more than one lot of shares, or if you think you may want to put other shares, unit trusts or investment trust shares in your plan, you should consider opening a self-select general PEP.

All the high-street banks offer those arrangements. For example, you can go into any NatWest branch and arrange to open a self-select PEP. Cheap telephone-based share dealing services are also available, such as Sharewise (01132 44095) whose charges start at 0.5 per cent a year and Sharelink (01212 339955) whose charges start at pounds 5 a quarter.

As well as the annual management fee, you should look at the dealing charges. Some PEP providers have a minimum dealing fee for buying and selling shares, which can make them expensive if you want to deal in small packages of shares.

If you already have a PEP, you may be able to shelter your windfall shares in that, but you may have to a collection fee of around pounds 4 for each dividend. Shelter several lots of windfall shares in your PEP and your dividend collection fee could be between pounds 16 and pounds 24.

Several PEP providers will accept your windfall shares and allow you to invest in their PEP. They will sell your shares and invest the proceeds in their managed PEP fund. Those PEP funds are either unit trusts or investments that invest in a whole range of shares, so instead of just having one set of shares, you will be invested in a whole range of shares. A minimum investment may be required.

Alliance & Leicester offered that option to its members, whose windfall shares were transferred into its capital growth PEP. But if you want to exchange your windfall shares for units or shares in a general PEP, it is worth considering other general PEPs as well as the PEP run by your building societyn

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