Your questions answered by Joe Coleman.
Q. I want to get down to some serious saving for that rainy day. I know there arelots of different methods of savings to choose from but Im a bit vague on what exactly PIPs and PEPs are. Are they a good method of saving?
A. With interest rates at their lowest level for 40 years, the best deposit accounts on the market are paying a maximum of 4% a mere 1% above inflation. Money on ordinary demand accounts is festering away below 0.5%. So its no wonder you are looking for a more exciting way to save money.
Q. What is a PIP?
PIPs (personal investment plans) are a relatively new concept which offer the option of saving over the medium term in an equity type investment. Regular monthly or lump-sum contributions buy investment units in a managed or specialist fund. The value of the fund is determined by the performance of the underlying assets.
A. The most popular PIPs are managed funds in which there is a spread of assets shares, government stocks, cash and some property, though most are heavily weighted in blue-chip company shares.
As a savings method PIPs are quite dynamic and flexible. The lowering of charges on such equity based savings plans means that surrender values in the early years are far more attractive than with similar plans in the past. Also, if your disposable income changes and you decide to save more or less, you can alter the amount you save every month without penalty (the minimum is usually 50 a month).
The fair way to assess growth or return on such plans is to look at what is referred to as the compound annual return (CAR). This gives you the average or annualised growth over a number of years, other returns that are often highlighted in advertising may be misleading. See the Table for a comparison of PIPs to other methods of savings.
PIPs have out performed inflation and most other short to medium term methods of saving. However, if you are averse to risk you may not be impressed by such figures, as PIP savings are not guaranteed. More and more people are gradually accepting the relation between risk and return. This is the reason that PIPs are recommended as a medium term method of saving (five years). With this type of investment there could well be the odd dip in fund performance.
Savers who have accumulated a lump-sum in a PIP can opt (within the PIP) to switch the accumulated savings into a cash fund, therefore guaranteeing their nest egg at that stage.
Q. So whats a PEP then?
A. Almost all savings are subject to DIRT (deposit interest retention tax). The DIRT rate on PIPs is set at 24%, ie. profits are taxed at 24% within the fund. PEPs on the other hand have a lower DIRT rate of 20%. For this concession the fund manager must invest a higher portion of the fund in smaller less secure holdings (indigenous Irish companies /unlisted securities). The logic behind the lower rate of DIRT is to attract the individual saver towards the PEP as against the PIP and therefore increase the flow of money into smaller growing Irish companies.
It is important to remember that PEPs can expose you to a higher level of risk. In the past the DIRT on PEPs was only 10% and this made them particularly attractive. However, the increased exposure to risk is difficult to justify considering the menial saving made with the current tax rate of 20%.
Q. Other issues?
A. As with all decisions on methods of saving and investments you need to first consider the following four factors in assessing whether the product suits your needs:
- Term when will you want to use the savings
- Risk v reward Security: capital and/or growth guaranteed, or exposed to risk.
- Liquidity - What are the penalties should you need access to the money earlier?
- Contribution - regular or lump-sum and is it possible to change the amount (flexibility).
Remember there is a degree of risk attached to equity based savings like PIPs. If the value of your PIP falls the sure way to lose your money is to withdraw your money. The trick is not to panic, wait for the markets to recover and then decide whether or not you want to stay in or get out. Investing in a PIP can also be an interesting experience as you can check your fund performance regularly through the papers and the Internet.
Joe Coleman is a senior consultant in the Nurses Division of Woodchester Brokers
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