Good-time PEP pill turns into a downer: Some personal equity plans may now be worthless

READ through the mountain of marketing literature promoting personal equity plans and nowhere will you find the words 'Unsuitable for Basic-Rate Taxpayers'.

Rarely either will you spot a mention that company dividends, the source of income for PEPs, have been faltering during the recession.

Stumbling company pay- outs, tax changes in the last Budget and continuing high fees have taken much of the gloss off many PEPs - except of course for the managers who collect the fees - and have made some PEPs worthless for basic-rate taxpayers choosing to invest now.

The chief attraction of a PEP is reclaiming the basic rate of tax deducted at source on dividends (the so-called tax credit). Unfortunately, one of Norman Lamont's last acts as Chancellor was to slash the credit from 25 to 20 per cent.

Pension funds and other tax-free institutional shareholders able to reclaim the credit duly kicked up an enormous fuss. But the sideswipe delivered to PEP plans was hardly noticed.

After the big rise in the stock market, the typical large company share yields 3.68 per cent gross, including the associated tax credit. So the investor receives a net dividend of 2.944 per cent - pounds 294.40p a year on a share portfolio worth pounds 10,000. Since the last Budget, the company running the PEP can now reclaim just pounds 73.60 on behalf of the taxpayer - 20 per cent of the grossed-up amount.

Unfortunately, many companies levy an annual charge of 1 per cent of portfolio value, even to investors in 'self select' PEPs who pick their own shares and so make no demands on managers' supposed investment abilities. The charge is therefore pounds 100 on the pounds 10,000 portfolio - enough to swallow up all and more of the pounds 73.60 saved by basic-rate taxpayers.

As a result, some investors would be better off without the PEP. If they stay in the PEP, only the PEP provider wins, while both the exchequer and the small saver lose out.

For basic-rate taxpayers who have chosen 'managed' PEPs, the situation can be markedly worse.

Barclays, which with PEP funds under management of more than pounds 1bn claims to be the largest provider, charges an annual administration fee on managed schemes of 1.25 per cent of the portfolio value. A basic-rate taxpayer with a pounds 10,000 share portfolio would pay pounds 125 a year in annual fees - far more, at current dividend yields, than his pounds 73.60 annual tax saving.

Most 40 per cent taxpayers still benefit from PEPs since by staying in they avoid the extra higher-rate tax payable on dividends. But even they must keep an eye on the impact of charges.

Many PEP providers charge a minimum annual fee of pounds 25. So on a small portfolio, the tax saving, even to a 40 per cent payer, is now rather modest. And the savings could disappear completely, eaten up by dealing costs, if the provider actively buys and sells shares in a managed portfolio.

Clive Hawkins, investment manager of Barclays Financial Services, admits: 'The incidence of charges is noteworthy in the early years of a PEP plan.' But he argues that in the years ahead, tax savings for PEP investors will outweigh the impact of charges.

However, this will be true only if dividends, and the associated tax credits, rise faster than share prices and the accompanying rise in management fees.

Indeed, for basic-rate taxpayers investing in the typical Footsie stock to show a profit, their dividends would have to rise by more than one-third - from around pounds 300 to more than pounds 400 net on a pounds 10,000 share portfolio. At pounds 400 net, the tax credit is equal to the typical management charge.

How many companies are likely to increase dividends by this much except over a considerable number of years? Many major firms are already paying out a very high proportion of their earnings in dividends. They are more likely to retain extra profits to repair their balance sheets than to make even more generous dividend payments.

The only other solution is to pick high-yielding shares - though big yields frequently go hand in hand with big risks. Even finding shares producing more than 5 per cent is tricky: according to Datastream, there are only six in the FT-SE 100.

Ladbroke tops the table but, as is often the case with such shares, the tempting 7.8 per cent yield reflects fears that the next step in its dividend will be down, not up. A cut in the pay-out hardly helps PEP investors.

Basic-rate taxpayers should therefore consider management charges more closely than ever before taking out a PEP. Asked why the promotional literature fails to highlight the pitfalls, the PEP industry's reply is candid but hardly reassuring. 'I think this would counter their marketing impact,' says Martin Dodd, liaison officer for the PEP Managers Association.

St James's Place PEP Progressive is the leading unit trust personal equity plan over three years with a rise of 135 per cent, according to Chase de Vere, the financial adviser. Its PEP performance charts, out last week, feature 550 unit and investment trust PEPs, as well as single company PEPs.

(Photograph omitted)

Suggested Topics
peopleFrankie Boyle responds to referendum result in characteristically offensive style
Arts and Entertainment
musicHunter Davies has collected nearly a hundred original  manuscripts
New Articles
Life and Style
lifeAiming to show breasts in a non-sexual way for cancer awareness
New Articles
i100... while following the referendum
ebooksAn unforgettable anthology of contemporary reportage
New Articles
i100... with this review
Holly's review of Peterborough's Pizza Express quickly went viral on social media
Arts and Entertainment
Nick Frost will star in the Doctor Who 2014 Christmas special
tvNick Frost, Natalie Gumede and Michael Troughton step up
Arts and Entertainment
Matthew Beard, Ben Schnetzer, Douglas Booth and Jack Farthing in ‘The Riot Club’
filmReview: Sheer nastiness of Riot Club takes you aback
Arts and Entertainment
tvBut something’s not quite right
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Senior BA - Motor and Home Insurance

£400 - £450 Per Day: Clearwater People Solutions Ltd: **URGENT CONTRACT ROLE**...

Market Risk & Control Manager

Up to £100k or £450p/d: Saxton Leigh: My client is a leading commodities tradi...

SQL Developer - Watford/NW London - £320 - £330 p/d - 6 months

£320 - £330 per day: Ashdown Group: The Ashdown Group have been engaged by a l...

Head of Audit

To £75,000 + Pension + Benefits + Bonus: Saxton Leigh: My client is looking f...

Day In a Page

Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments
These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

Widespread fear of Isis is producing strange bedfellows

Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
Topshop goes part Athena poster, part last spring Prada

Topshop goes part Athena poster, part last spring Prada

Shoppers don't come to Topshop for the unique
How to make a Lego masterpiece

How to make a Lego masterpiece

Toy breaks out of the nursery and heads for the gallery
Meet the ‘Endies’ – city dwellers who are too poor to have fun

Meet the ‘Endies’ – city dwellers who are too poor to have fun

Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

Ian Paisley’s decision to make peace with his IRA enemies

His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam
'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

Exclusive extract from Janis Winehouse's poignant new memoir
Is this the role to win Cumberbatch an Oscar?

Is this the role to win Cumberbatch an Oscar?

The Imitation Game, film review
England and Roy Hodgson take a joint step towards redemption in Basel

England and Hodgson take a joint step towards redemption

Welbeck double puts England on the road to Euro 2016
Relatives fight over Vivian Maier’s rare photos

Relatives fight over Vivian Maier’s rare photos

Pictures removed from public view as courts decide ownership
‘Fashion has to be fun. It’s a big business, not a cure for cancer’

‘Fashion has to be fun. It’s a big business, not a cure for cancer’

Donatella Versace at New York Fashion Week