Investment: Taxing problems - Staying single is a risky business in PEP trades

SINGLE COMPANY PEPs offering the prospect of tax-free investment present several questions. Is it worth getting one? Is it a suitable investment? Which PEP manager and which shares offer the best prospect of a healthy return?

Answers to these questions are easy to understand, but one must remember that a single company PEP is a more specialist investment than a general one.

They need careful consideration. As the end of the tax year approaches, investors appear to be flooding into them. Fidelity says its sales of single company PEPs from the start of the year to 10 February are up 223 per cent on the similar period last year.

But single company PEPs are not suitable for everyone, and they are far less popular than general PEPs, even taking into account this year's rush.

Jason Hollands, managing director of BESt Investment, the financial advisers, says: "Single company PEPs are not appropriate for the vast majority of private investors."

There are two reasons single company PEPs are often unsuitable. First, each year's single company PEP requires direct investment in the shares of only one company. This makes them a risky investment.

If you invest the allowed annual maximum of pounds 3,000, its return will depend entirely on the fortunes of your chosen company. For wealthy investors this may not be a worry: they will have other investments, and the relative risk will be small.

But for most people pounds 3,000 is a lot of money, and investing it all in a single company PEP is a bad idea. Investments should be diversified to spread risk.

Investors also need to remember that shares in single company PEPs should be viewed as long-term investments. You can sell the shares in a single company PEP and switch to another company's shares so long as you do not hold cash for more than 42 days. And some single-PEP providers will offer to manage the investment for you, buying and selling shares in an effort to maximise your return.

But dealing charges and stock market volatility mean you should expect to hold shares for a minimum of five years. Investors looking for a short- term investment should try elsewhere.

The second concern about the suitability of single company PEPs is over the value of the tax breaks that they offer, and whether these outweigh their initial fees and management charges. For some people they will, but for others they will not.

There are two tax savings offered by a PEP: one is on capital gains tax (CGT), and the other is on the tax payable on dividends.

CGT is payable only on capital gains over pounds 6,800 in a year so, for many people, single company PEPs offer no benefit here. They will not have such tax liabilities.

As for dividends, after 5 April changes in the tax laws mean that tax benefits on dividends make a significant difference only for higher rate taxpayers.

Mr Hollands says: "With the cuts in tax credit dividends, single company PEPs are almost certainly inappropriate for anyone who isn't a top-rate tax payer, or who doesn't have capital gains tax liabilities."

Buy if a single company PEP does make sense for you, there are several pieces of general advice. Make an effort to shop around for the best deal. Initial fees and management charges vary considerably from one single company PEP provider to another. To find the best deal, contact several stockbrokers or investment companies offering them.

You will also need to consider whether you want an execution-only stockbroker, probably offering lower charges, or a traditional stockbroker or investment company that offers advice on choosing shares.

When picking shares, think about your priorities. Fred Robinson, a partner at the stockbrokers Killik and Co, says: "Your stock selection will depend very much on how it fits in with your portfolio."

Jim Wood-Smith, head of research at Greig Middleton, says: "The attitude we take towards single company PEPs is that it is best to think safety first. We go for large blue-chip stocks where we are as sure as we can be that people will make money in the long term.

"What we don't do is use single company PEPs as tax-free speculating vehicles. If you take a punt and get it wrong you've lost on your tax break."

The Independent has produced a last-minute "Guide to PEPs". The guide, by Nic Cicutti, this paper's personal finance editor, discusses whether PEP investments might suit your needs, what the tax benefits are - and aren't - and details of the rules.

If you are considering a last-minute PEP, this guide, sponsored by Scottish Widows Fund Management, is for you. Call 0345 678910 for your free copy.