The PEP gamble

Iain Morse advises on the pros and cons of investing a windfall from a former building society

These are happy days for shareholders in the Halifax, the former building society that floated on the stock market on Monday. Halifax shares, first tipped at 415 pence last year, reached 775p in early trading, before drifting lower by close of play. Still, anyone selling the minimum 200 shares through Halifax's free sharedealing service cleared a tidy pounds 1, 450 or so.

Of course, more than five million have decided not to sell for the moment. Many have already decided not just whether to keep their shares, but how they intend to do this. But for a large number of former Halifax members - and those with shares still to come from Norwich Union and the Woolwich - a decision, perhaps long temporised over, still needs to be made. As always, a key issue is whether to PEP or not.

In recent months, many companies have promoted the tax-free benefits of PEPing. But is it worth going down that route?

Take the Halifax. The company, as it now is, offers a single company corporate PEP with annual charges of 0.5 per cent plus VAT, but with a minimum cash charge of pounds 10 plus VAT, or a total of pounds 11.75 per annum. On a minimum holding of 200 shares, currently worth about pounds 1,500, this works out at just under 0.75 per cent in charges a year. If Halifax share prices fall, as many experts predict, the cost of the PEP goes up accordingly. Of course, those with 400 shares from a savings and mortgage account do pay 0.5 per cent plus VAT - at least as long as the shares don't fall below a value of pounds 4.70.

Two weeks ago, Norwich Union, the UK insurer, declared the terms of its windfall and a discount shares offer for members. For policy holders who have with-profit endowments, and pension plans, the minimum windfall will be 300 shares, while for policy holders with non-profit policies the minimum will be 150 shares.

Based on the public offer price of 240-290 pence, these windfalls will be worth pounds 720-pounds 870 and pounds 360-pounds 435 respectively. Members will also be able to buy discounted shares at 25 pence per share, or about 10 per cent of the public offer price.

Along with these windfall shares comes windfall advice. Norwich Union is offering a single company corporate PEP for windfall shares. There is no cost for transferring shares into this, and no management charge for the first year. Thereafter, the annual management charge will be 0.5 per cent of fund value. This sounds too good to be true. But, as with most such offers, there is a catch. Norwich Union also imposes a minimum annual cash charge of pounds 11.75.

On a holding worth pounds 720, this puts the annual charge up to 1.63 per cent, while for a holding worth pounds 360 the same charge stands at a whacking 3.26 per cent. Of course, there are fixed costs to running such a plan, but these figures make PEPing a windfall less attractive.

This is a corporate PEP; you cannot choose to sell the Norwich Union shares and replace them with those of another company. If you want a change, then at best you could transfer the PEP to another manager, with associated costs, or close it down. The dealing costs are 2 per cent for the first pounds 500 of shares sold, and thereafter a flat charge of 0.5 per cent. This is pricey, measured against charges made by discount brokers.

One can only hope that, like Halifax shares, Norwich Union shares rise astronomically in value - but the fact that a sizeable tranche of shares is being offered to institutions makes this unlikely.

A brief survey of other windfall PEPs tells a similar story.

Alliance & Leicester offers only a full select PEP with annual charges of 1 per cent. This plan is far more flexible than a single company PEP and can be used to take other windfall shares. But the minimum cash charge is pounds 22.50 plus VAT, a total of pounds 29.37. This means that a fund value of pounds 1,500 would be paying charges of just under 2 per cent a year.

One purpose of a PEP is to ensure that dividend payments are received tax free. One way to ready-reckon whether a PEP is worthwhile is test the effect of charges. Our table compares how high the annual yield on shares would have to be at basic and higher rate of tax to offset the charges levied on a PEP.

If dividends from the shares cannot meet these charges, then small packets of shares will be sold to provide a minimum cash balance. This will add dealing costs to the shareholders' burden. During a prolonged bear market, with share prices falling, such PEPs could prove very expensive.

The moral of the story is simple. Anyone contemplating putting windfall shares into a PEP should work out their approximate value, then check on whether this falls below the threshold where minimum cash charges come into effect. If your shareholding is above average, and you are a higher- rate taxpayer, PEPing is worthwhile. If the reverse applies, the plan may well not be worth taking, as charges will bite hard into dividends and growth.

Annual Management

Charge 0.5% 1.% 1.5% 2%

Break-even yield on

23% basic rate tax 2.50% 5.00% 7.50% 10.00%

Break-even yield on

40% high rate tax 1.25% 2.50% 3.75% 5.00%