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The History fo ISA's and PEPs The story so far The ISA succeeded the PEP and the scope of both has got wider over the years, with the result that some investors now have sizeable tax-efficient investment portfolios In the beginning, there were Personal Equity Plans – PEPs. Well, not in the beginning exactly, but certainly at the start of 1987, when the PEP was the big idea of the then Chancellor of the Exchequer, Nigel Lawson, to encourage more people to invest in the stock market. PEPs were, in fact, unveiled in the 1986 Budget and initially were very much focused on individual shares, as the name suggests. Chancellor Lawson wanted to build on the success of the programme of privatisation issues that the Conservative government was engaged in at the time, with the aim of expanding individual share ownership and encouraging investment in UK industry, and, initially at least, there was a positive bias against collective investment funds. There were many differences between the original PEP scheme and the ISA regime that we have today. Not only was investment focused on UK-listed companies, but a maximum of only £2,400 could be invested, the investment limits applied to a calendar year rather than the tax year and there were restrictions on when you could take your money out. However, one core principle was established, which has characterised both the PEP and ISA regimes ever since. The incentive for people to invest in these vehicles was that all the income generated by, and any capital gains realised from, the investments were tax-free, so long as they remained within the PEP environment. Over the years, a number of changes were made to the PEP rules to make them more attractive to investors, such as increasing the amounts that could be invested, increasing the proportion that could be put into collective investment funds, ultimately to 100 per cent, and aligning the ‘PEP’ year with the tax year, rather than the calendar year. For a while, there was also the opportunity to make extra contributions to a separate single-company PEP each year, in addition to your main PEP, which, as the name suggests, allowed you to invest in the shares of a single quoted company. This was something of a sop to Chancellor Lawson’s original vision of a ‘share-owning democracy’ and was never wildly popular with the investing public. By 1990, the Chancellorship had passed to John Major, who introduced another tax-free savings vehicle, the Tax-Exempt Special Savings Account (TESSA). These were designed as a balance to the equity-orientated nature of PEP investments, by providing for the investment of cash into TESSA-designated deposit or share accounts, generally operated by banks or building societies. Politics being what it is, however, PEPs and TESSAs were unlikely to survive the change of government in 1997, but the popularity of these tax-efficient investments had been well established by this point, with the result that quite quickly upon assuming office Gordon Brown announced a replacement for both along similar lines. And so the ISA was born. The idea was to build on the positive aspects of PEPs and TESSAs, but to broaden their scope and encourage a wider range of people to make long-term savings. The other key aspect of the changeover was that, although no new PEPs or TESSAs could be opened after 5 April 1999, existing plans could continue. Whilst TESSAs had a fixed life of five years and, therefore, had to either be cashed or rolled over into a TESSA-only ISA when they matured, PEPs continue to operate under the PEP regulations until the PEP is closed. Also, all PEPs taken out by the same individual over a succession of years can be consolidated into a single PEP portfolio. This means that, although no new money can be put into PEPs, they can still be managed with all the tax advantages that come with the PEP rules. TESSA investors could subscribe their matured TESSA proceeds to a cash mini-ISA, the cash component of a maxi-ISA, or to a TESSA-only ISA, within six months of the TESSA maturity date. Since the last TESSA matured on 5 April 2004, it has not been possible to transfer TESSA capital into an ISA since 5 October 2004. The ISA scheme has also developed since its introduction nearly a decade ago, particularly in terms of the range of investments that can be included, and the rules governing these investments have been extended to include PEP portfolios as well. Not all the changes have been perceived to be positive, however. The reduction, and then removal, of tax credits on dividend income from shares, for example, has significantly reduced the attractiveness of equity income investments within ISAs and PEPs. But, by and large, the development of the PEP and ISA regime has been seen as positive, not least because it means that PEP and ISA investors can adopt much more balanced investment strategies. Paul Ilott, senior investment adviser at Bates Investment Services, points out: “Before April 2001, the old PEP rules tended to distort PEP portfolios, because any fund qualifying for PEP status needed to have at least 50 per cent exposure to the UK and/or other EU countries. This meant that investors tended to overweight UK and European funds massively in their portfolios. Many investors have maintained this distortion despite the PEP rules having been amended to mirror the ISA stocks and shares rules, which allow exposure to any recognised international stock market. As a result, it is now possible to build much more robust portfolios even for PEP funds originally invested in prior to the rule change in April 2001.” Another important point, which is as valid for today’s ISAs as it was for yesterday’s PEPs, is that by making maximum use of each year’s contribution limits, you can build up a sizeable portfolio, which remains free of income tax and capital gains tax. Anna Bowes, savings and investments manager at Chase de Vere Investments, comments: “One of the things I like to point out about ISAs is that if you had invested each year, you could have invested over £140,000 and you could easily now have half a million invested in something that is tax-free for encashment, which is phenomenally valuable.” She adds: “It is something that I get a bee in my bonnet about, that all the negative press about ISAs is putting people off, but it is important to point out that there are still advantages. Yes, it was a huge disappointment that the government decided to take away the extra benefit of having tax-free dividends, but, for a higher-rate taxpayer, there is no extra tax to pay and ISAs will still be protecting your investment from the potential of any capital gains tax, or of any bother, because if you make any encashment of any other investment, you need to tell the Inland Revenue about it, even if you are not a higher-rate taxpayer. You need to inform them, so it potentially stops you from having to fill out a tax return form if you do not do one normally.” Bowes bases her assertions on an analysis of investment performance since the beginning of the PEP and ISA era. She explains: “If you had invested the maximum amount in PEPs and ISAs from the beginning, you would have invested £140,200 by the end of December 2005. I thought it would be interesting to see what sort of returns you could have achieved over that period. I looked at simply the UK All Companies sector to do a valuation, because investment in PEPs was in the UK only at the very beginning, showing the performance if you had invested on the first day you could have at the beginning of the relevant year. You could have invested £140,200. If you had been in the average UK All Companies unit trust each year, you would have over £300,000 now. If you had been in the best-performing trust each year, you would have £754,000, and if you had been in the worst-performing one, you would have £180,000, so would still have made some money” (see table below). Related Stories
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