Grab a slice of your boss's profits
Fiona McLaren, 50, who lives in Edinburgh, thinks employee share schemes are a no-brainer. She has worked for Marks & Spencer for 15 years, currently as a projects co-ordinator with the employee relations group, and started saving into the M&S employee share scheme as soon as she could.
"I started with £10 a month, but now I save the maximum £250," she says. "It's easy to save because the money is automatically deducted from your salary each month.
"At the end of the three-year savings period, you can choose to buy the shares at the pre-agreed price, plus an extra 20% discount, so I felt there was no reason not to join."
According to ifs ProShare, which promotes employee share ownership in the UK, roughly two million people in the UK own shares in the firms they work for.
But there are still plenty of eligible employees who are missing out – employee benefit consultant Hymans Robertson says take-up for some schemes averages just 20% of the workforce.
Employers like the share schemes because, as well as being tax-efficient, they help build employee loyalty and motivation – staff members with a stake in the firm have all the more reason to want it to do well. But as Fiona has discovered, they can also be a great way of getting a slice of the company profits.
There are two main types of plan – the Save As You Earn (SAYE) scheme and the Share Incentive Plan (SIP). Both enable staff to buy shares in their companies at a much lower cost than on the open market.
Like Fiona, Rosemary Arnold, 45, who works for the publishing arm of media giant Pearson, is a member of a SAYE scheme.
Over the past 15 years, she has been tucking away £50 a month into three- or five-year SAYE schemes offered each year by the company, each time building up a few thousand pounds which she then ploughs into discounted Pearson shares when the scheme matures.
"I did very well in the 1990s when Pearson shares rose to about £19 – they're around 730p now. It meant that when I had a big credit card bill to pay I was able to sell some shares to pay it off. And even after cashing those in, my remaining shares are still worth more than the money I've paid into the savings scheme," she says.
Rosemary usually holds on to the shares she has bought rather than selling them, partly because the six-monthly dividend payments come in handy, and partly because she believes Pearson is a solid company with a healthy future.
So how does a SAYE scheme work? Anyone signing up to a SAYE scheme can save between £5 and £250 of taxed income each month into the employer's special SAYE savings account. Typically, plans run for either three or five years, though some companies offer a seven-year option.
At the end of the term, you have the option of using the cash to buy shares in your company - but the big attraction is that you're buying them at the price fixed at the beginning of the scheme, regardless of what's happened in the markets since. On top of that, the company discounts the price by up to 20%.
If company shares have gone up over that time, it makes sense to buy at the previously fixed price and then either sell or hold on to them for the longer term. But if the share price has fallen to lower than the discounted price, you can take the cash instead.
Julie Richardson, head of ifs Proshare, says: "This makes this scheme effectively risk-free – even if the company goes bust, your savings are held separately and are protected under the Financial Services Compensation Scheme."
To illustrate the benefits of this scheme, Lauren Peters, head of financial education at Moneyinmind.com (run by Killik Financial Services), gives the example of 'Rachel', who decides to join her firm's scheme.
She chooses to pay £50 a month into the five-year plan – a total of £3,000 – with the option of buying shares at £2 each at the end of the contract.
Peters explains: "Five years later, the market value per share is £4, so she exercises her right to buy £3,000 of shares at £2 each. She is therefore able to buy 1,500 shares, which she can then sell for £4 each. Since 1,500 x 4 is £6,000 she's made a profit of £3,000, effectively doubling her money."
On the other hand, if the company shares have lost value over the period, she can take the cash instead.
This normally earns tax-free interest at a rate set by HM Revenue & Customs, with an additional tax-free bonus payable on maturity.
With the second type of scheme, the Share Incentive Plan (SIP), you can choose to pay up to £125 a month (£1,500 a year) and your money is then used to buy so-called 'partnership shares' in the company.
As Richardson points out: "The money comes out of your salary before tax is deducted, so £100 of shares will only cost you £69."
Moreover, your employer can opt to match the shares you buy with additional shares, up to two for every one bought. But as Chris Noon, a partner at Hymans Robertson, comments, most companies aren't that generous.
"Most match on a 25% or 50% basis – so that it's one share for every four or two you buy," he says. The company may also choose to give employees up to £3,000 worth of 'free' shares each year, perhaps instead of a cash bonus.
However, SIP shares are extremely tax-efficient, particularly for 40% and 50% taxpayers. They have to be held in a special trust, and provided you leave them there for at least five years, they are free of income tax for as long as they remain within the trust, and free of capital gains tax if you sell them directly from the trust.
As the aim is to use tax to encourage employees to hold onto their shares, the tax breaks are less attractive for shares held for shorter periods.
Free and matching shares cannot be cashed in within the first three years, and while you can withdraw partnership shares at any time, you'll need to pay tax and national insurance on them.
Any shares sold within three to five years will attract income tax and NI on either the purchase price or their current market value, whichever is lower.
However, SIP schemes aren't as low-risk as SAYE ones.
"A SIP is a slightly risky investment as the employee buys the shares at the outset, and of course their value could go down," explains Peters. "But the risks involved are quite small if you've received matching or free shares from the employer; the share price would have to drop dramatically for you to lose money."
"Which scheme is best for you will depend on your circumstances," says Richardson. "SIPs offer greater tax savings, especially for higher-rate taxpayers, but they're riskier. If you're a lower-rate taxpayer and you don't want that risk, then you're better off with a SAYE plan."
Weighing up the pros and cons
Of course, risk can take various forms, so you need to consider several factors before you sign up to any scheme. Firstly, these are medium- to long-term investments, so if you think you will need cash at short notice, they are probably not for you.
Secondly, there's always the risk that the company you work for could go bust, in which case you'd lose not only your income but also your investments.
"Even previously 'solid' companies have found themselves in trouble recently; Connaught, for example, has gone into administration after around 90% of its share value was wiped out in just three months," Richardson warns.
Other recent casualties include Woolworths, Viyella, Barratts Shoes and Northern Rock. But even if your company doesn't fold, its share value may fall significantly.
And at the end of the day, the same principle of making sure you diversify your investments applies to these schemes too. When you can sell your shares it's worth investing at least some elsewhere to ensure you don't have all your eggs in one basket.
Should I invest in my employer?
Five questions to consider before signing up to a share scheme...
1 Can you afford to tie your money up for up to five years?
2 Do you have an emergency cash fund?
3 Are you paying into a company pension?
4 Do you understand when you can access your money and how it will be taxed?
5 Do you think your employer has what it takes to survive during the current economic uncertainty?
Save as you earn
A tax-efficient cash saving scheme that lets employees save towards buying shares in the company they work for at a discounted price. At the end of a specified term, participating employees have the option to buy shares in the company or take the savings in cash. The share option works like a warrant, with a special share price set (known as the option price). If the company’s shares have increased in value when the term is finished, employees can buy the shares at the option price. If the shares are worth less than the option price, the employee simply takes the cash.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.