So you think you want a PEP?

PERSONAL EQUITY PLANS How do these investments work? Are they safe?

Q: A PEP is a Personal Equity Plan, right? It is a kind of unit trust containing a number of different shares, but I get the dividends paid tax-free and any profit I make does not count as capital gains tax, right?

A: Right.

Q: And I can take the money out of the PEP again at any time, without having to pay back tax?

A: Right again. With a tax-exempt Tessa deposit account you lose the tax advantage if you take your money away in less than five years. With a PEP there is no such limitation. PEP providers recommend holding the PEP for at least three years, preferably five, to give yourself a reasonable chance of coming out with a gain rather than a loss.

Q: Sounds too good to be true. So what's the catch?

A: Well for one thing, shares are shares. The dividends are not guaranteed, they are usually less than the same investment would earn on a deposit in a bank or building society, and although share prices go up more often than down in the long run, you could just find yourself needing to sell in a short run. And you may not invest more than pounds 6,000 a year in a general PEP, plus a further pounds 6,000 for your partner.

Q: So who chooses the investments to put in the PEP?

A: The PEP manager - usually a bank, a unit trust group, or a stockbroker - chooses qualifying shares, units or investment trusts to put in a managed PEP and does the administration for you in return for ...

Q: I know, in return for a fee, a charge, which will wipe out all the benefits from the tax concessions, I suppose?

A: Well, yes, and no. Some managers waive their initial fees to get you in, and charge you a withdrawal fee instead if you decide to take your money away in less than, say, five years. But all managers will charge an annual management fee, which will cost you, regardless of whether, or how much, the value of your PEP goes up or down.

Q: Can I choose the shares myself to put in my PEP rather than pay the charges?

A: Yes, you can have a self-select PEP, from Fidelity and other managers, where you choose the shares yourself, and it will cost you less. But there will still be a charge of some sort.

Q: Are there any specialist PEPs or are they all general?

A: Well, PEPs invested in unit trusts and investment trusts may be specialised, but most are linked to general UK or, perhaps, high income trusts. Gartmore Shaw operates a PEP that invests only in utilities, and it has been making great play of its performance, thanks to the possible bids for water and electricity companies. Richard Branson's Virgin Direct will sell you a "tracker" PEP that selects the shares to buy and sell by computer in order to track or follow the FT All-Share index.

Q: Can I have a PEP containing unit trust units or investment trust shares, rather than shares in individual companies?

A: Yes. Originally there were restrictions on the amount of unit trusts and investment trusts you could hold in a PEP, but they have been steadily relaxed. The rules now allow investors to have shares, unit trusts, investment trusts, or a mixture of all three, in a PEP. But you still have to buy your units at one price and sell them at a different price. The difference can be as much as 5 per cent and will run away with a slice of your capital.

Q: Can I have a PEP containing shares in just a single company?

A: You can invest up to pounds 3,000 a year in a single company PEP, in addition to the pounds 6,000 you put in your general or self-select PEP. But you cannot put the pounds 3,000 single company PEP into an investment trust.

Q: Is there a right time and a wrong time to buy a PEP?

A: You can only invest up to the annual limit, and there is nothing to be gained from buying when the stock market looks like falling from a cyclical peak. But many advisers do recommend that their clients make sure they have their annual entitlements before the middle of March, to qualify for the end of the tax year.

Q: You talk about lump sums. If I don't have pounds 6,000 to invest, can I contribute to a regular savings plan?

A: Yes. Many PEP providers will allow you to invest lump sums as small as pounds 500 to pounds 1,000 a year, or regular savings contributions as small as pounds 30 to 50 a month. The charges for buying unit trusts via a savings plan are the same as for a lump sum investment, but it is a less painful way to accumulate.

Q: Do I have to take the dividends and how will they be paid?

A: Usually they are paid quarterly or half-yearly tax free by the PEP provider, whose job it is to reclaim the tax on your behalf, but you can roll-up and reinvest the dividends for maximum appreciation.

Q: So who should buy a PEP?

A: Investors who already invest in shares and unit or investment trusts, and are not likely to panic if they see the value of their investments falling, and dump them at a loss. It was also expected to appeal mainly to higher-rate taxpayers, who would get most benefit from having tax- free dividends. In fact, more standard-rate taxpayers have invested than higher-rate taxpayers. They use them as tax-efficient savings plans, as pension supplements and as ways of paying off their mortgages.

Q: Last , but not least, is there any political risk?

A: Honestly, we don't think so. The post-war Labour Party soaked the rich with extra taxes on investment income. The Labour Chancellor, Sir Stafford Cripps, was a byword for austerity at that time. The investment income surcharge lasted into the 1980s.

It took Margaret Thatcher's Conservative government and its Chancellor, Nigel Lawson, then Chancellor, to tip the balance the other way. But the change is now entrenched. New Labour, under Tony Blair, shows no inclination to turn the clock back.

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