Personal Equity Plans: The pros and cons

ANY INVESTOR considering the merits of investing in a PEP will have many questions. Here are some of the most common.

Why invest in a PEP?

If you are looking for capital growth or income, or a balance of the two and you are hoping to make more than if you placed your money in a building society deposit account, it makes sense to invest in one. That said, perhaps you may not be a taxpayer, in which case, simply investing in one of the PEP's underlying investment products may suit you just as well.

What are the benefits of a PEP?

Broadly, it is the fact that income from a PEP is tax-free. And if you keep your money invested, this income rolls up in a tax-free environment.

What about capital gains?

Capital gains tax (CGT) is payable on the first pounds 6,800 of realised gains in the current tax year. So you would need to see substantial profits from your PEP investment before benefiting from its tax-free environment.

What happens if I take out more than one general PEP in a year?

The taxman will catch you. When you take out a PEP, you have to give your National Insurance number, which allows the Inland Revenue to do a cross-check.

What are the risks of a PEP?

They vary from PEP to PEP. But essentially, they are the same risks as with all equity-linked investments. Basically, the value of your fund can fall as well as rise, and you could get back less than you have invested - although this is not the case with some "guaranteed" funds.

This could affect the income stream you may be expecting from a PEP. That said, over a longer period of time, the world's largest stockmarkets have delivered better returns than through a bank or building society account.

Can I have PEPs for my kids?

PEPs are a good way to save for a child's education. You cannot open one in a child's name, though. If your children are over 18 and UK residents, they can open one for themselves. You can fund their PEP, although the cheques into it must come from them, not you.

What can I use PEPs for?

The list is probably endless. You can use PEPs to help pay off a mortgage in just the same way as with old-style endowment mortgages. They will help pay for your kids' education and are very useful as pension top-ups.

How long should I keep a PEP?

Unless you are thinking in terms of at least three years, don't invest in a PEP. Most financial advisers recommend at least five years. Ten gives more of a chance to smooth out the stockmarket's ups and downs.

What about charges?

Charges vary substantially. You could find yourself paying an initial charge of up to 6 per cent, plus an annual management fee of up to 1.75 per cent. This means that if you were investing only for the short term, the initial charge on a PEP could well cancel out any growth in the first year.

How would I cash in a PEP?

Simple. You contact the company concerned, give them notice of encashment by filling in a form they will send you, or by sending in a letter, and a cheque will be on its way to you within weeks. Remember though: once you have cashed in that PEP you will lose that year's PEP entitlement forever.

What about partial encashment?

The same applies as above. Beware of penalties for partial withdrawals.

What about transferring between PEP providers?

There is no problem with switching between one fund manager and another. You can switch without affecting this year's allowance. But to retain your PEP entitlement your new manager must do the donkey work - do not sell the PEP yourself, with the aim of setting up a new one.

How can I transfer?

The new manager will send you a transfer form to fill in. there may however be a problem. Some PEP managers administer their plans so that each year's separate PEP is amalgamated with previous years'.

Can I switch between funds under one manager?

Usually that is not a problem. If the investment sector you have been in is not doing well, or the fund you are in has turned out to be a dog you can move. There may be transfer charges.

Is there tax to pay if I switch from one fund to another?

By transferring your shares, you are effectively selling the old ones and buying new ones. But because this is done within a PEP, there will be no tax to pay.

Can I add to my PEP?

Yes, as long as it is within the annual pounds 6,000 limit for general PEPs and pounds 3,000 for single company PEPs. Bear in mind that once that tax year is over, you cannot add to that year's PEP.