Special Report on Personal Equity Plans: A financial shelter for the longer term: What are the advantages of a PEP? Christine Stopp examines the types of scheme on offer, the charges, and the choice of investment strategies

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The Independent Online
DO YOU need a Personal Equity Plan? For most people who are saving seriously for the long term the answer is yes.

Some have argued against PEPs on the grounds that the tax benefits are insignificant to the smaller investor. Freedom from capital gains tax may not be all that useful, given the exemptions, but a share-based portfolio which is free of income tax offers an undoubted advantage over the longer term. As the graph shows, 'longer term' means at least 10 years.

Not all PEP holders are small investors. A married couple can now put pounds 18,000 between them into PEPs each year. Since the start of PEPs in 1987 to the end of this tax year, they could have invested a total of almost pounds 75,000. Within a year or so, stockbrokers will have clients with PEP portfolios of over pounds 100,000. Already many private client brokers are finding that most or all of their portfolios are sheltered in a tax- free PEP home.

PEPs now cater for the smallest to the largest sums. The new edition of the Chase de Vere PEPGuide lists 700 plans from 200 fund managers, divided into more than 20 categories. Quite a few offer a regular savings option with minimums as low as pounds 25 in some cases, though pounds 50 or pounds 100 is more common. The commonest lump sum minimum is pounds 1,000.

A general PEP allows you to invest pounds 6,000 each year in any share or shares quoted on an EC stock market or in qualifying collective funds - unit trusts or investment trusts. A single company PEP allows a further pounds 3,000 in the same year in a single share. You can put pounds 6,000 into a unit trust and pounds 3,000 into a share, or spread the pounds 6,000 between shares, unit trusts and investment trusts in any combination, or you could put the whole pounds 9,000 into one shareholding.

The first choice to make is between shares and funds. For all but the very large investor, funds are the obvious choice since they give a much better spread of risk. Most fund PEPs are run by investment managers for use with their own funds, though a few offer a choice of management group.

The next decision is whether you want to choose your own investments, or let someone else do it for you. A fund PEP will usually let you choose the trust (or it may offer only one trust).

PEPs which include shares may offer 'managed' or 'self-select' arrangements, whereby they will choose for you or leave the choice up to you. Some self-select PEPs let you choose the shares you want from a specified list of companies.

The greatest freedom is in a completely self-select PEP which will allow you to choose any combination of shares or funds. These are mostly available through stockbrokers, and will probably cost more than those which give less flexibility.

If you are the sort of investor who is happy to choose a general fund and stay invested for years without switching, a unit trust or investment trust PEP will be fine. If you want to switch from split capital investment trusts to European shares and back into UK blue chips, you will need a self-select option.

There are PEPs on offer with a variety of different investment objectives, some of them illustrated in our article on brokers' recommendations. Because dividends are tax free in a PEP it is a good idea for most smaller investors to choose a high-yielding plan. The dividends can be paid out or left to accumulate in the fund, to be taken as tax-free income at a later date. An increasing number of plans offer a monthly income.

There are low-yielding growth PEPs on offer, some of them with a substantial percentage in overseas investments. This is possible because any EC share can be included and up to pounds 1,500 of the PEP allowance can be in a 'non- qualifying' trust, which has more than 50 per cent of its holdings outside the EC. There are very few PEPs which will invest direct in overseas markets. In practice, this is almost always done through a fund.

What are the costs of all this choice? They vary enough from plan to plan to make it well worth shopping around, but competition has brought costs down in the last year, and a number of special offers are currently available. The main charges to look at are the initial and annual charges and the dealing costs on share investments.

It is hard to generalise about levels of charging, though many PEPs imitate the unit trust charging structure, with 5 per cent initial and 1 - 1.5 per cent annual charges. Some charge flat fees, which will favour the larger investor. A pounds 50 initial charge is clearly much less significant to someone with pounds 6,000 than to someone investing pounds 1,000. Some plans make a fixed charge per holding, which can rapidly escalate if you have more than one stock in the portfolio.

Unit trusts have their own inbuilt initial and annual charges. Few unit trust PEPs double charge. The few which do, look very expensive compared to the average. Fidelity made news last year by reducing its initial PEP charge to 2 per cent and operating a redemption charge of up to 3 per cent if the plan was cashed in during the first three years. Since most investors expect to hold their plans long term this is an attractive form of pricing which is being copied by other managers - mostly those whose initial charges are low.

There may be other charges to watch out for, for example on switches within the PEP, attending the AGMs of companies in which you hold shares, or collection of dividends. Most plans will allow share exchange - that is, you hand them share certificates and they sell the shares on your behalf and put the money into a PEP. There may be special terms on the share-dealing involved.

With all the variations available it is easy to forget that the main object of a PEP plan is to achieve a return. It is pointless to choose a cheap unit trust plan whose performance record is poor. Having decided on a PEP whose objectives and features meet your needs, a careful look at its performance compared to competitors is paramount.

The table shows performance of the top five qualifying unit trusts and investment trusts and the top five FT-SE companies over five years to 1 January.

Chase de Vere PEPGuide; pounds 9.95 from Chase de Vere Investments PLC, 63 Lincoln's Inn Fields, London WC2A 3JX (telephone 071- 404 5766).

------------------------------------------------------------------------ PERFORMANCE OF PEP INVESTMENTS ------------------------------------------------------------------------ Qualifying unit Qualifying investment FT-SE 100 trusts trusts Companies (offer-to-offer) (mid-to-mid) (mid-to-mid) pounds pounds pounds Baring European TR City of Rentokil Growth 2,381 London 2,565 Group 6,579 Newton Income 2,280 F&C Eurotrust 2,398 Inchcape 4,653 Scottish Widows Scottish Mortgage Lloyds Bank 4,431 European 2,278 (Baillie Gifford) 2,383 Guinness 4,177 SGTR European Edinburgh Inv. BAA 3,974 Special Sits. 2,225 Trust (Dunedin) 2,357 Fidelity Electric & General European 2,175 (Henderson) 2,461 ----------------------------------------------------------------------- Source: Chase de Vere's PEPGuide. Table shows result of pounds 1,000 investment over five years to 1.1.93, gross income reinvested. Top five investments in each category. -----------------------------------------------------------------

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