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ISAs are ready for take-off

FED UP WITH all the last-minute PEP hoopla, the endless exhortations to invest now before this wonderful tax break disappears for good? By the time you read this, it will be almost too late to start a PEP.

Not to worry - you can set up an Individual Savings Account (ISA) instead. As far as tax is concerned, the rules for ISAs are the same as those for PEPs: exemption from capital gains tax, freedom from income tax, but with the diminishing benefit of dividend tax credits, which drop to 10 per cent from April this year and are abolished in five years' time. Even so, investors seeking a first-time tax-free haven for their cash are best off looking at ISAs.

So what are the ISA investment rules? In 1999/2000, one may invest up to pounds 7,000, and pounds 5,000 a year in subsequent years. This compares with a maximum of pounds 9,000 into regular and single-company PEPs, plus pounds 9,000 into a Tessa over five years.

Permitted investments in an ISA will be far broader than under the old PEP/Tessa regime. PEP rules specify that up to pounds 1,500 of the annual pounds 6,000 allowance for a full PEP can go into "non-qualifying" funds. The rest must go into UK and European Union equities and bonds. ISAs will have up to three components: equity, cash and insurance. The equity part will be allowed to hold "any share traded on any recognised stock exchange anywhere in the world".

What this relaxation of the rules will allow is far wider choice of asset allocation. If you want to invest your whole annual allowance into, say, an emerging markets fund, you will be free to do so.

Fund managers plan to take advantage of this rule change. While they will be offering in ISA form all the funds already available as PEPs, they will also be offering previously "unPEPable" funds too. Investec Guinness Flight, for example, is preparing to offer 14 funds, including its Global High Income fund - previously not even available as a non- qualifying PEP fund - through an ISA account. This invests in mainly Western government bonds.

Another important difference is that ISAs will be permitted to hold a far wider range of fixed interest securities such as UK and foreign corporate and government bonds. With the exception of UK gilts, all of these must have five years or more until maturity when bought into the ISA, but can be sold out of it at any time. Any gain on such a disposal will stay "inside" the account free of tax.

Over the shorter term, gilts, National Savings certificates and cash deposits with less than five years to maturity can be held in an ISA. Onedistinctive feature of ISAs will be their use of CATmarks. The aim of these is to ensure a "fair and reasonable deal".

Applied to the cash and insurance elements of ISAs the CATmarks will indicate low minimum premiums, few penalties, and surrender values reflecting the value of underlying assets in an account.