A tax haven for the millions

PEPs are the people's investment choice. Here and on pages 16- 19, learn how to choose and use them

IF YOU invested the full amount allowed in a personal equity plan (PEP) every year since they first became available nearly nine years ago, you could now have more than pounds 100,000 sheltered from all tax in PEPs.

To date nearly 6 million general PEPs have been taken out worth in total more than pounds 20bn. In addition, 630,000 more specialised PEPs - those investing in a single company's shares - have also been taken out, worth a further pounds 2bn. Certainly more than a million people, perhaps more than 2 million, now have PEPs (many have bought more than one over the years).

PEPs are simply tax shelters that protect the dividends and capital gains produced by shares, bonds, and unit and investment trust funds from tax.

"They are a rare gift from the Government encouraging you to draw income and profits tax-free from the stock market," says Philip Warland, director- general of the Association of Unit Trusts and Investment Funds, which represents the majority of unit trust providers in the UK. "Since they were introduced they have become a must for any investor. With the personal tax haven of a PEP, you can pocket all the investment income and all the profits without giving a penny away in tax." The vast majority are unit trust PEPs, and most unit trust sales are now in PEP form.

Every tax year, investors may buy one general PEP and one single-company PEP. A general PEP can hold a wide selection of company shares, bonds or unit or investment trusts, or a combination. As its name suggests, a single-company PEP can hold the shares of just one company. However, although investment trusts are structured as companies, their shares may not be held in a single-company PEP.

The limit on investment in a single-company PEP in any one year is pounds 3,000 but, combined with the general PEP allowance, this allows investors to save up to pounds 9,000 a year tax-free. Investors can either save between pounds 10 and pounds 500 a month, or invest a lump sum from as little as pounds 50.

Because of their tax advantages, PEPs can outperform most other available investment products over the longer term. An investment of pounds 1,000 in the average UK Equity Income unit trust PEP five years ago would have grown to pounds 1,447 now, compared to pounds 1,349 in the average unit trust and pounds 1,359 in a building society account, according to Autif, the unit trust trade body.

UK Equity Income is a popular type of fund for PEP investors; it consists of shares with a higher-than-average income. After 10 years, the PEP would have been more than pounds 2,000 ahead of the cash deposit, and after 15 years nearly pounds 8,000 ahead. Over 25 years, the pounds 1,000 would have grown to pounds 46,057 in the PEP, but only pounds 5,849 in the building society.

Our chart shows these longer-term benefits as well as shorter-term ups and downs of PEPs, or any stock market investment, against the performance of building society savings.

PEPs are flexible. Investors can invest for income or capital growth. They may cash in their savings whenever they choose, usually without penalty. They may also switch between PEPs, from high to lower-risk or from growth to income, without losing the tax benefits. This makes them ideal as a savings vehicle for all sorts of long-term goals, including paying off a mortgage, planning for retirement alongside existing pension plans or paying for a child's education.

The annual limit for investment in PEPs started off at pounds 2,400 in 1987 but has risen slowly over the years. The pounds 6,000 level that operates today was introduced in 1991. Today, investors may put the entire pounds 6,000 into any "qualifying" fund, a move that has led to the predominance of unit trust PEPs.

Alternatively, up to pounds 1,500 in a year may be invested in "non-qualifying" investments, such as emerging markets or gilt funds, without forgoing tax benefits.

When PEPs were first introduced, only UK companies were eligible to be held in the tax shelter, but now unit and investment trusts qualify for inclusion in a PEP if at least 50 per cent of their portfolio is made up of UK or other EU shares.

In the last Budget, the Chancellor extended the range of qualifying investments to include corporate bonds, preference shares and convertibles, paving the way for the launch in July this year of high-income corporate bond PEPs. This allowed for a totally non-equity investment - 50 per cent in qualifying corporate bonds, preference shares and convertibles, and 50 per cent in gilts - to be promoted under a PEP wrapper for the first time. This new type of investment is designed to to appeal to investors who want to generate income but are cautious about the risk involved in investing in shares.