COMMENT
Make 32% A Year, Tax Free!

By Cliff D'Arcy
September 20, 2005

In recent years, I've been less than impressed with my wife's largest investment, which is also our second-biggest asset.

That's because the investment in question - thousands of shares in her employer - consistently underperformed the wider market in 2002, 2003 and 2004. However, things are looking up for her company: its shares are up by 13% this year, matching the All-Share's performance, and I remain optimistic about its future performance.

So, how could a share that has persistently lagged the wider market provide a tax-free return of 32% a year, as I claimed in my title? It's all down to the beauty of employee share schemes, where workers can buy discounted shares in their employer. The particular scheme is question is Sharesave, also known as the Save as you Earn (SAYE) or Savings-Related Share Option scheme.

Sharesave is the UK's most popular all-employee share plan, with around 2.6 million participants across 1,300 approved company schemes, or about an eleventh (9%) of all UK workers. Under Sharesave, employees are given a right (known as an 'option'), but not an obligation, to buy shares at a future date, at a price determined shortly before the option is granted. Companies can discount the option price by up to a fifth of the market price, which greatly boosts employees' returns.

After saving a monthly sum of between £5 and £250 for three or five years, Sharesave investors receive a tax-free bonus. Their capital plus bonus can then be used to buy shares in the company. If the option price is above the market price, investors will lose money by exercising their option, so they can just pocket the cash and walk away. Thus, Sharesave offers the best of both worlds: exposure to shares, with a small guaranteed return!

Here's an example, using my wife's three-year Sharesave from 2002, which will mature later this year. Her option was priced at a 20% discount to the market price in September 2002.

By saving £250 a month for three years, my wife will have amassed £9,000, plus a tax-free bonus of 1.8 monthly contributions (£450), giving a total of £9,450. Due to the option, she will be able to buy shares worth £14,260.

So, although her company's share price has only risen by 21% since September 2002, thanks to the Sharesave discount, my wife has turned £9,000 into £14,260 over three years, a return of 58.4%. Aha, but she didn't put in a lump sum, she saved monthly and, according to our Savings Calculator, this equates to an annual return of over 32%, compounded. Result!

Furthermore, given that Mrs D's current capital gain of £4,810 is within the £8,500 Capital Gains Tax allowance for 2005/06, if she wishes to sell any or all of these shares, she can do so without paying a penny in tax. For the record, my wife has subscribed to every company Sharesave scheme since the early Nineties and has taken the cash only once, back in the fierce bear market of 2000/02. This gave her a tax-free return of about 4% in one of the most devastating periods in British investing history, which she was happy to collect!

Of course, you can only invest in this particular Sharesave if you work for this firm. However, if you work for any stock-market listed firm, check to see if it offers Sharesave or another share incentive plan. While joining an employee-only investment scheme can never be a totally one-way bet, it can help to make you considerably richer!

You can learn more about Sharesave and other employee share schemes at the ifsProshare website.

More: Get cheaper share-dealing here and save tax with an ISA | How Your Employer Can Make You Rich.