Don't get caught out by charges

Independent research shows that most investors choose a PEP for the published yield it offers, and often ignore the charges they will have to pay, which are deducted from the PEP regardless of how it performs. Until recently, it was quite normal for some PEP providers to pocket as much as 5.5 per cent of the investor's cash and invest only the balance, as well as charging an annual management charge of up to 1.25 per cent a year plus VAT to run the fund. You do not have to be a financial wizard to see that could work out more expensive than paying 25 per cent income tax if the dividends yielded less than 5 per cent.

But new providers like Virgin and Marks & Spencer quickly saw that simplicity and a no-frills approach would attract investors who were suspicious of the traditional investment mumbo-jumbo, and they have used low charges as a direct sales point. In the last 12 months competition has led most of the mass-market providers to reduce initial charges and several big providers have abolished them altogether. Only the specialist providers who can boast good past performance can now get away with big charges.

Most of the new corporate bond PEPs have had no initial charges, although some deduct their annual charges from the income while others take it off the capital in order to maximise the published yield from the dividends at the expense of the capital value.

The new wave of index tracker funds introduced by Virgin, Legal & General and HSBC/James Capel, have also used the fact that they do not need an army of analysts to pick winners if they are simply aiming to match the stock market as a whole, and can therefore eliminate initial charges.

Main corporate bond PEP providers like Legal & General and Fidelity now charge as little as 0.50 per cent to manage funds. Some independent financial advisers like Best PEP offer investors a rebate on their commission, which further scales down the cost of buying a PEP.

Investors in self-select PEPS face a management charge if they want the stockbroker to manage the portfolio and to collect the tax which will have been deducted at source. If they want to buy and sell shares in their portfolio they will also have to pay a dealing commission to the broker.

Nowadays investors can be pretty sure the tax-free income and gains from investing through a PEP will more than justify the residual charges. But everyone should be aware of the charging structure as well as the performance figures before they buy.