PEP's

Guide to Personal Equity Plans (PEPs)

What is a Personal Equity Plan (PEP) ?

A Personal Equity Plan allows you to enjoy the profits from stockmarket-related investment free of income tax and capital gains tax.

When PEPs were introduced in 1987, the idea was to encourage people to buy company shares (remember popular capitalism?) but the range of possible PEP investments was ultimately widened to include unit trusts and investment trusts not to mention corporate bonds.

Unfortunately this appears to have been such a great idea that the Inland Revenue got a bit hot under the collar about all the tax it was missing out on. This means you can't get any more PEPs but you can hang on to the investments you have already made.

2) What did the government promise and what did it do?

New Labour's 1997 election manifesto said: "We will introduce a new individual savings account and extend the principles of TESSAs and PEPs to promote long-term saving. We will review the corporate and capital gains tax regimes to see how the tax system can promote greater long-term investment."

In practice, this meant the abolition of TESSAs and PEPs, two successful tax-efficient ways of saving and investing, to be replaced by Individual Savings Accounts (ISAs), with less attractive tax breaks and a lower annual limit on contributions.

3) So does that mean PEPs have gone for good?

You may no longer invest fresh funds via a PEP. The scheme was withdrawn with effect from April 6th, 1999, the start of the 1999/2000 tax year. At the same time, the new ISAs came into being. However, any savings already invested or sheltered in PEPs at that point are allowed to remain in PEPs with tax breaks now broadly similar to those offered under ISAs.

You may well be one of millions of people who invested in a PEP in the 12 years they were on offer and have been left wondering what to do with the savings you have accumulated. Estimates vary, but between £60-90 billion pounds has been salted away under the tax-efficient wrappings of personal equity plans. Most of us are likely to have built up our PEP portfolios on a piece-meal basis and it is probably time we reviewed our holdings.

4) So how much could I have squirrelled away in PEPs?

Initially you would only have been able to invest in UK equities and at least 75% of the investment had to be directly held in equities. The rules were changed gradually over the lifetime of PEPs. The direct investment requirement was dropped, qualifying investment status was extended to European Union shares and part of your investment could also be in 'non-qualifying' investments (up to a maximum of £1,500 in non-UK or EU invested funds. Corporate bonds and preference shares were also introduced, allowing you to invest in a fixed interest PEP. Separately a second scheme was introduced allowing you to invest in shares in a single company.

Had you invested the maximum allowable each year into PEPs you would have been able to shelter a total of £88,200 from the taxman. Given the performance of the stockmarket over the late 1980s and through the 1990s, anybody who had actually done so will be sitting on a tax-sheltered PEP pile worth up to a quarter of a million!

5) So how do PEPs work now?

You may not take out any new PEPs or invest more money in those you already have. However, any savings invested in PEPs before April 6th, 1999, will still benefit from the same tax breaks as the new ISAs. That is to say, they are free from capital gains tax and free of income tax. After 5 April 1999, you will still have no tax to pay on income or capital gains from PEP investments.

Prior to April 6th, 1999, dividends paid by UK companies carried a 20% tax credit and PEP investors received payment of these credits. From April 6th, 1999, the value of this tax credit fell to 10% and it will be payable to PEP investors for five years from that date.

6) Can I switch investments?

Yes. With a discretionary PEP, the Plan Manager will decide to buy or sell investments on your behalf. With a non-discretionary PEP, you can tell the Plan Manager which investments to buy or sell. Remember that the Plan Manager is likely to make a small charge to switch investments between funds under management.

You may want to change the company in whose shares a Single Company PEP invests. If so, you must tell the Plan Manager to sell all the shares in the PEP and re-invest the proceeds, plus any cash held in the PEP, in your selected company. To maintain the tax status of money invested in a single company PEP the proceeds from such a sale of shares must be reinvested within 42 days.

P .E. P.'s Buy form. Click to go to the online form.

It is possible to sell part of your single company PEP holding to realise any gains but this will cut into the value of the tax-free investment. You may buy new shares up to the cash value of any that you sell and retain the tax benefit. Changing shares in this way is likely to incur a charge from your PEP Manager of, typically, between 1% and 2%.

7) What can I do if I am unhappy with my PEP?

There may be many reasons why you become dissatisfied with your PEP. You may think the charges are uncompetitive or the performance is poor. You may decide that you want a change of management style, or that you want to switch from a PEP that is aiming to grow your capital to one that intends to provide an income.

You have the right to transfer your PEP from one plan manager to another at any time, although the Plan Manager may make a charge for doing so. You must transfer your entire PEP, not just part of it. You cannot split a PEP between two or more Plan Managers. You may not transfer the ownership of your PEP to someone else.

Many people assume that, because they bought their PEP in a certain tax year, they cannot touch it until they want to cash in their investment. This is not the case. You are perfectly at liberty to transfer a PEP allowance from a past tax year to a new provider. Your financial adviser or the PEP providers concerned will show you how to proceed.

8) How do I go about transferring my PEP investments to another Plan Manager?

Your needs may have changed. An original requirement for capital growth may no longer be what you want and you may prefer income. If this is the case, check what alternative investments your existing Plan Manager can offer. Transferring investments under your existing PEP umbrella is going to be cheaper than shifting to a new Plan Manager.

However, you may wish to transfer to a Plan Manager with a better PEP performance record. You must move a whole tax year's general PEP at a time, even though these savings may be split between a number of investments. Partial PEP transfers are not allowed. There are also some restrictions on moving between qualifying and non-qualifying funds. Remember there is a limit to the amount of money your PEP can invest in non-qualifying funds (those with less than half their assets in Britain or Europe).

Be aware that some firms, in fact around two thirds of Plan Managers, have bundled together all their clients' investments even though they were made in separate years. This means that instead of having a handful of little PEPs you will have just one big one. Remember Inland Revenue regulations mean that if you wish transfer your PEP you must transfer it all and not just part of it.

9) How much does running a PEP cost?

Costs vary enormously according to whether you hold shares, unit trusts or investment trusts. With shares held directly, there'll be a stockbroker commission every time a trade is made; managed funds, such as unit or investment trusts will have charged you an initial fee as well as an annual management charge. These are set as a percentage of the amount you invest. e.g. between 0% and 6% for an initial charge and up to 2% for an annual management charge. You may still face initial charges if you are transferring PEP funds to a new Plan Manager. Most of them treat transfers as new business although some are discounting initial fees for transfers or making cut-price offers for investments over certain amounts.

Your existing Plan Manager may also make a charge for the withdrawal of funds. Such transfer penalties vary from 0% up to 5% in some cases for transfers within one year. There is also likely to be a small fee for leaving the PEP scheme which is likely to be between £25 and £50 plus VAT.

You can minimise the cost of transferring your investments by using an independent financial adviser who will negotiate a reduced fee or by using a discount broker who will refund commission, providing you do not need advice.

Always remember, low charges are attractive, but cheapest is not always best. Just like star footballers, fund managers can be worth the money they are paid (but not always!). It's always as well to watch out for the ones who charge heavily but who fail to deliver the investment performance to compensate.

10) What happens if I move abroad or die?

Moving abroad will not affect your PEP investments. The income and the capital gains will continue to be exempt from UK tax. However, PEPs are not transferable between people. On the death of a PEP investor, the tax status of the PEP ceases. Any capital accrued so far remains tax free but any future capital gains and dividends become liable for tax from the date of death. Thus, a PEP cannot be transferred or passed on to a surviving spouse or any other beneficiary. However, the assets sheltered within the PEP may, of course, be bequeathed in the normal way.