Special Report on Personal Equity Plans: Stock market risks can pay off nicely: In a world of falling interest rates a high-income PEP may be the answer - if you accept it can be a gamble, writes Anthea Masey

SAVERS WHO rely on the income from their bank and building society accounts are being urged to switch to high-income PEPs to get a better return. But with the stock market testing new highs, is this the right time to change from safe bank and building society accounts to higher-risk stock market investments?

There is no easy answer to this question, and it is hard to think of a time when people faced such difficult investment decisions. All you can do is arm yourself with the facts and make up your own mind.

If you rely on the income from your savings and are suffering from the recent cuts in bank and building society rates, but do not like the idea of putting your money at risk on the stock market, all you can do is check that you cannot get a higher rate by switching to another bank or building society. Many smaller building societies offer higher rates than the big high-street names.

And if you have not already done so, transfer some money into a Tessa. These are five-year tax- free bank and building society savings schemes. You can invest up to pounds 3,000 in the first year, pounds 6,000 for couples. The interest is tax-free if you keep the money invested for five years, and the interest rate on these schemes is usually higher than on many other accounts.

If, on the other hand, you are prepared to put your money at risk for a higher rate of return, you might think about transferring some of your money into a high- income PEP, remembering always that the higher the income, the higher the risk.

So what are the facts? Under PEP rules you can put up to pounds 6,000 a year into a general PEP, pounds 12,000 if you are a couple. With a new tax year looming, this means that a married couple could transfer a total of pounds 24,000 out of bank or building society accounts into a high-income PEP over the next couple of months. PEPs are tax- free, so you don't have to pay tax on the income, and when you sell there is no capital gains tax to pay.

The Inland Revenue gave the high-income PEP a festive boost with the announcement just before Christmas that unit trusts and investment trusts which split their portfolios equally between shares and fixed-interest investments such as government stocks could be included in a PEP. This mix offers a high income at a lower risk than an investment entirely made up of shares and provides a useful half-way house for investors who might be nervous about the stock market.

This month, Fidelity launched its High Income unit trust. The fund, which is invested half in shares, half in fixed-interest investments, offers an income of

6 per cent. The PEP charges are

2 per cent initially, and 1.25 per cent a year. Fidelity's charges are low because they encourage investors to stay invested, with penalties of 3 per cent if you want your money back in the first year, reducing to nil after four years.

M & G Managed Income Fund is a new unit trust from M & G which also takes advantage of these new PEP rules. Here the manager can adjust the amount of the fund that is held in fixed interest investments, depending on M & G's view of the market. At the moment, the fund is 80 per cent invested in shares, 20 per cent in fixed interest. The income is 5 per cent and the charges on the trust, which are the same whether or not you buy your units through a PEP, are 4.5 per cent initially and 1.5 per cent a year.

Investment trusts are the place to look if what you want is a really high income. Look for the income shares of split capital investment trusts, but get advice before you take the plunge and be prepared to keep a vigilant eye on your investment. Lorraine Goodhew of Private Fund Managers, who advises people on their investment trust holdings, says she is concerned that people don't appreciate the risks associated with income shares. 'People look down the yield column in the Financial Times and they see figures of 16, 19, even 24 per cent. Someone wrote to me the other day with a list of these high income shares asking me what I thought. It was clear he had no idea how risky these shares can be. Some work like annuities and will lose all their value over the life of the trust.'

Having sounded this word of warning, Ms Goodhew does use income shares if she is sure people understand the risks. For example, if she was constructing a high- income PEP for a client she would put pounds 3,000 into the income shares of General Consolidated and pounds 3,000 into the stepped preference shares of Scottish National, to give an income of 8 per cent. On 3 February the income shares of General Consolidated cost 119p and the yield was 10.6 per cent. These shares will lose money if they are held until the trust is wound up at the end of 1997, when the income shareholders get pounds 1 a share. However, this loss is offset by the capital appreciation on the stepped preference shares of Scottish National. These shares, on 3 February, cost 154.5p and the yield was 5.6 per cent, rising by 5 per cent a year. Scottish National is wound up at the end of September 1998, when the stepped preference shareholders get 171p a share.

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