The plans are simply wrappers that allow you to put up to pounds 6,000 a year into the investment of your choice - whether unit trusts, investment trusts or individual shares or bonds - and take the returns free of all tax.
In the years after PEPs were introduced in 1987, a big problem was the extra charges which often bit hard into the returns, offsetting the benefit of the tax breaks. However, as they have grown more popular, charges have been cut back. Nowadays, with unit trusts, the PEP nearly always comes at no extra charge. And in some cases unit trusts are cheaper in PEP form than stand-alone. This sets unit trust PEPs apart from those investing in investment trusts or direct in shares or bonds - where the PEP wrapper costs extra.
But there are restrictions on which unit trusts you can choose for your PEP. To be able to put the full pounds 6,000 annual allowance in a trust, at least half of the fund must be in UK or European stock markets. Since July this year, funds which invest at least 50 per cent in corporate bonds also qualify fully. Only pounds 1,500 a year can be invested in other unit trusts.
Another restriction is that you can only invest in one pounds 6,000 PEP - called a general PEP - each year. You can spread your allowance between more than one trust in the same plan, but not between different PEPs.
With many unit trusts it is true that the tax saving of using a PEP will be small - most people do not fall into the capital gains tax category, while the income tax saving on most stockmarket invested trusts will be perhaps 1 per cent or even less a year. But investors should also consider their future tax position - basic-rate taxpayers might move into the higher- rate band, for example, and a Labour government might raise tax rates. So given the lack of extra charges, it makes sense to shelter your investments if you can.
There are almost as many different kinds of unit trust as there are people wanting to invest. However, as a rule, you should aim to hold the investment for at least five years. A spokesman for the Association of Unit Trusts and Investment Funds (Autif) says if you think you might need access to your money within five years, you might be better off with an ordinary interest-bearing savings account.
Some PEPs provide a high income, which is useful if you are relying on your savings for an income. Others aim to build up the capital value of your investment, protecting it from inflation, and still others provide both income and growth. There are more than 500 unit trust PEPs to choose from, so it may well pay to consult an independent financial adviser.
Graham Hooper, investment director at independent adviser Chase de Vere, says the most important factors to consider when choosing a PEP are its past performance, charging structure and volatility, and the identity and philosophy of the fund manager.
"The problem is many investors look only at the past performance of a fund when choosing their PEP. They can often be very disappointed when their annual report arrives." Mr Hooper says that often a top-performing manager will have moved on or the good performance will have been achieved by taking risks. Most investors are unaware of this.
But for investors who worry that all this seems a little too risky, there are other options. First-time investors often opt for index-tracking PEPs. The index trackers follow a given index, often the FT-SE-A All-Share, which accounts for the top 700 companies in the UK. Thus if the index rises 8 per cent, the investment ought to be fairly close to that. But remember the same applies if the value of the index falls.
Simon Davies, senior portfolio manager at the independent adviser Berry Asset Management, believes index trackers are an "admission of failure. The whole point is to try and beat the index," he says. However, for many fund managers this is a futile task, and at least you can be fairly sure you won't do much worse.
Corporate bond PEPs have attracted a lot of publicity recently. They are often touted as ideal for the first venture away from the building society. And although the income on offer can look good - at 7 or 8 per cent - Mr Davies warns that the prospect of your capital actually growing is practically nil.
Perpetual's PEPs are among the most popular on the market because of their flexibility and good performance. If you buy one, you can invest in its four UK funds - high income, income, UK growth and UK small companies - in whatever combination you like. All are in the top quarter of funds in their respective areas, says Perpetual's Roger Cornick.
Other popular ranges come from M&G and Fidelity. M&G has two PEPs with no initial charge - Managed Growth and Managed Income. Fidelity has a range of 15 unit trusts, with monthly saving and lump sum options. Its MoneyBuilder PEP, which also has no initial charge, has proved popular recently.Reuse content