The relentless rise of the popular PEP

Long-term investors will prosper with personal equity plans, whether they're funding retirement or school fees. Tony Lyons reports
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The Independent Online
Since Nigel Lawson introduced them nearly 10 years ago, personal equity plans, more familiarly known as PEPs, have been a spectacular success. They are highly tax-efficient - among mainstream investments, only pensions carry greater tax breaks. Dividends are free of income tax and there is no capital gains tax to pay, providing the PEP has been held for more than a year.

PEPs are also a very versatile form of long-term savings whether they are invested in shares, unit trusts, investment trusts or fixed-interest stocks. They provide additional funds for retirement, and can be used to pay for mortgages, education, medical and even dental care.

If you are over 18 you can invest up to pounds 6,000 in any tax year (as a lump sum or monthly installments) in a general PEP - one that invests in several companies. You can also invest a further pounds 3,000 a year in a single-company PEP, which holds shares in just one company. As everyone has their own PEP allowance, a married couple can each invest the maximum.

The only exception is that if the money is put into shares or units that are invested outside Europe, the maximum that can be invested is pounds 1,500 per person.

The PEP must be taken out with a licensed PEP manager - a definition that includes financial institutions, brokers, fund managers and other specialists

The biggest managers are the high street banks which have more than pounds 1bn each in their PEP plans. You are only allowed to have one general PEP manager in any tax year, but can use a different one in a new tax year. You can, however, use a different manager for a single-company PEP.

Since the advent of direct marketing of PEPs by groups as diverse as Virgin and Direct Line, the costs of running a PEP have become fiercely competitive. Generally, initial charges levied by plan managers for setting up a scheme vary from nil to 5 per cent. Annual management charges are usually between 0.7 and 1.5 per cent. Some groups have exit charges if the plan is cashed within five years. All PEPs levy dealing charges for buying and selling shares and all incur Stamp Duty of 0.5 per cent for share purchases.

Essentially, there are fourtypes of PEP plans available:

q Single-company PEPs - offered to those who want to invest up to pounds 3,000 a year into an individual company. Most of the familiar corporate names, such as Abbey National and Marks and Spencer, offer such schemes.

Much of the money invested in single-company PEPs has come from employees of firms who want to share in the future financial success of their enterprise. Employees can often transfer shares they already own into a single-company PEP free of charge.

q Self-select PEPs - usually offered by stockbrokers and independent financial advisers. The plan manager invests in a selection of funds offered by other management groups or a basket of qualifying shares and units for the long term. The manager may offer advice on which stocks to invest in, for which there is usually a charge.

The only difference from direct ownership of shares is that the investor may not be eligible to attend the annual general meetings of the companies invested in or to receive reports.

q Managed PEPs - offered by a wide variety of management groups, most commonly unit trust groups, followed by investment trusts. Investors use their PEP allowance to purchase units in the chosen fund. Usually, the funds reinvest the tax-free income to buy additional units and so build up the value of the fund over time.

The most common investment vehicle to date has been UK growth funds. But tracker funds that invest in the stocks that form the FT-SE 100 index are proving increasingly popular as very few funds seem to outperform the index on a long-term basis. For a small fee, some plan managers are beginning to offer a guarantee that over five years there will be no depreciation in capital even if the underlying investments fall during that time.

Most management groups now offer their PEP plans to those who want to save on a regular basis. The minimum investment is usually between pounds 25 and pounds 50 a month with the main unit and investment trust groups. By investing regularly, investors avoid the pitfall of putting their money in when prices are at a peak.

q Corporate bond PEPs - for those who are averse to risk and want an income higher than a building society deposit account. Available since last year, these invest in a variety of bonds, preference shares and convertibles. They pay a fixed dividend each year with a lower risk to capital than ordinary shares and units.

Most investors use corporate bonds to supplement income, usually in retirement, and there are now more than 60 on offer. According to the Association of Unit Trust and Investment Trusts, the average corporate bond has produced an income of 7.1 per cent tax free over the past year - nearly double that of a conventional deposit account - and the capital has remained intact.