For example, a five-year PEP back to back plan would typically have taken about 40 per cent of a lump sum to provide a temporary annuity for five years. This is simply a way of saying that the money plus interest on it is paid out to the investor over five years, so that at the end there is nothing of it left. The remaining 60 per cent of the capital would be reinvested and no income taken from it.
The aim is that it will grow back to equal the total original capital by the time the income runs out at the end of the five-year period. To do so it needs a growth rate of just over 10 per cent after charges.
A plan taken out with one of the earliest PEP providers, Save & Prosper, would have achieved that objective if it was maturing now. Because the plans included shares and the composition of the portfolio changed they are not as easy to measure as unit trusts, but a five-year plan is currently showing a profit of about 94 per cent. However, other PEP holders have not been so lucky, particularly if the back to back plan ended before the recent stock market rise.
There must be a question mark over the concept of back to back PEPs. Essentially they combine an investment in shares (the PEP which is supposed to recoup the capital) and in five-year government stocks (which dictate the annuity paid over five years for the lump sum invested). It is now possible to invest through PEPs into special unit trusts comprising up to 50 per cent in cash and government stocks to provide a degree of additional stability without breaking the qualifying unit trust rules for a PEP. So why be tied to the rigidity of a five-year plan?
Advisers know that investors are lured by the promise of a high 'guaranteed' income. Such incomes are created by cashing in capital in the hope that it can be recouped from the remainder of the investment, but with no guarantee that it will be.
Investors would be better advised to live off the income that their PEP produces rather than sacrificing capital to artificially create income, and then reinvesting the PEP income to artificially recoup their capital.Reuse content