Investment trusts: Pop it in a PEP and avoid paying tax

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The Independent Online
Investment trusts not only offer good value in terms of their performance track record and low charges, they can, in many cases, also deliver returns to savers free of tax. Tony Lyons explains how "pepping" can be good for you and what the rules are.

Personal equity plans (PEPs) have proved themselves one of the best means of long-term saving for taxpayers. In his July Budget, Gordon Brown, Chancellor of the Exchequer, announced that they would be replaced in 1999 by Individual Savings Accounts, or ISAs. Details of the new savings vehicle will not be available until next year. Until then, PEPs still have many attractions and should be used.

An individual can put away up to pounds 6,000 a year into a general and pounds 3,000 a year into a single-company PEP with all dividends and capital growth being tax free. Only one PEP manager can be used in any tax year and to qualify for the full advantages, investment must be in equities traded on the London or one of European Union stock exchanges.

Investment trusts, with their low-charging structures, are one of the best vehicles for anyone thinking of starting a PEP. They offer investors the ability to participate in a wide portfolio of shares which is professionally managed and has the chance of long-term growth.

Some investment trusts are non-qualifying. This is because either they already invest more than half their funds in stock markets outside the European Union or the fund manager wants to have this option open.

In the case of these funds, only pounds 1,500 can be invested in them via a PEP. But a management group with a good spread of funds will be able to offer both qualifying and non-qualifying trusts.

Investors with windfall shares from building societies and insurance companies converting to public company status can use them either to start a PEP with an investment trust or add them to a plan.

Windfall shares are treated as having zero value if put into a PEP within 42 days, leaving the full pounds 6,000 allowance intact. Most investment trust managers make a small charge for accepting them in a PEP, while others make no charge.

Anyone starting a PEP will now be able to see the total effect of charges, something that was not compulsory until 1 May 1997 when the disclosure rules changed. These show how the projected values of an investment will be affected by all the deductions and expenses, including commission paid to advisers, which bear on a fund assuming standard growth rates of 9 per cent.

As investment trusts are listed on the stock market, their share prices are constantly changing. This is unlike unit trusts, which usually fix their prices at the end of each working day. Generally, while investment trusts can have more administrative costs, including paying fees to directors and custodians, they also have lower charges than unit trusts.

While both types of fund normally charge a setting up cost for a PEP, the only other charge they carry is 0.5 per cent for stamp duty, as with any share purchase.

Some managers may impose a dealing charge for buying and selling shares. Unit trusts, however, include an initial charge, usually between 1 and 5 per cent, which is reflected in their prices.

Annual costs vary with many investment trust PEP managers charging up to 1 per cent, sometimes with a cap on the maximum amount an investor will have to pay.

This compares with the 3 per cent to 5 per cent annual management charges made by unit trusts.

If no charges were made, a pounds 6,000 investment would be worth pounds 9,232 after five years and pounds 14,204 after 10 years, assuming growth of 9 per cent a year. Following full disclosure, the effect of costs and charges would reduce this for the average investment trust to pounds 7,929 and pounds 11,212 respectively.

Nowadays, most investment trust managers will also accept monthly or quarterly payments into their PEPs through regular savings plans. These can start as low as pounds 20 a month.

"Savings plans will iron out any stock market volatility," says Ernest Fenton of the Association of Investment Trust Companies. "With them, long- term investors do not have to worry about timing their investments."

While charges are important, performance matters more. It is better to invest in a fund that shows outstanding growth than to put money into one with low charges and no growth.

An independent financial adviser should be consulted for guidance on which investment trust would best suit the aims of an individual investor.

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