FOOL'S EYE VIEW
Free Money From Your Employer

By Cliff D'Arcy
January 14, 2003

Figures going back to 1869 show that, given enough time, shares have produced superior returns by out-performing other investments such as cash, bonds and property. But what if you're not a pension fund and don't want to salt your money away for half your lifetime? Most investment experts will tell you that investing in shares is best considered over at least five, preferably ten, years.

One way to increase the odds in your favour is to invest in shares in your own company. At this point, present and past employees from fallen companies such as Marconi and Railtrack may run from the room screaming!

Despite the high-profile collapses of several giant firms in the last three years, investing in your own company is still a valid proposition. The technique is not to buy your shares in the stock market but to acquire them directly from your employer.

There are two main ways of doing this:

1) Savings-Related Share Option (SRSO) Schemes

Share options have caused uproar in the US and UK. Many executives have been criticised for awarding themselves massive share-option packages or manipulating their company's share price in order to enrich themselves.

Options merely give holders the right (but not the obligation) to buy shares at a pre-determined price at some future date. They are usually "exercisable" from three to ten years after the date they are granted. As a share price rises, these options become more valuable (but will create a loss if the "exercise price" is higher than the prevailing market price at the time of exercise).

However, many UK companies distribute share options to all employees, linked to monthly savings plans. SRSO plans have been offered in the UK for over 20 years, also known as Sharesave or Save As You Earn (SAYE). Currently the most popular employee share scheme, there are more than 1.75m employees participating in over 1,200 SRSO schemes across the UK. 92 out of the UK's 100 largest companies offer a SRSO scheme. Since introduction, the initial value of shares and options awarded under these schemes exceeds £35b.

As the name suggests, these are share options linked to monthly savings, offered to all employees. As an incentive, the employer can price these options at a discount of up to 20% to the share price at the time of grant.

Usually, you are invited to save a monthly sum from £5 to £250 over a period of three, five or seven years. At the end of the savings term, you can choose to withdraw your cash, together with a tax-free bonus. You may choose to do this if the current market price is below your option (or "strike") price. So, if your company's share price has crashed, you can take the money and lose nothing.

Alternatively, you could use some or all of the lump sum and bonus to buy shares from the company ("exercise the option"). You may then decide to keep the shares or sell them at a time when they are showing a profit.

Example 1:

Duncan saves £250 a month for three years in Dunco's SAYE scheme, a total of £9,000. He receives a tax-free bonus of 2.75 x £250 = £687.50.

Dunco options were granted at 80p three years ago, a 20% discount from the market price back then. Dunco's share price has risen to 140p, so Duncan decides to buy 12,109 shares at 80p, instead of taking out his £9,687.50.

He exercises his option, buys the shares and sells them immediately, making 12,109 x 140p = £16,952.60. Duncan doesn't have to pay income tax on this money and, as his gain of £7,265.10 is less than his annual capital gains tax (CGT) allowance of £7,700, he doesn't have to pay CGT either.

A happy Duncan is now even more motivated, loyal and committed to the Dunco cause! More details on the technicalities of SAYE schemes can be found here.

2) All-Employee Share Ownership Plan (AESOPs)

Despite their name, these are not fables! We'll focus on one of the popular features of AESOPs, Partnership and Matching shares.

Quite simply, you can buy shares out of your pre-tax income and be given free shares by your employer at the same time. You can save 10% of your salary in this way, up to a maximum of £125 a month. Your employer can then add up to two extra free shares for every share you purchase.

If you withdraw your shares from the scheme after five years or more, you won't pay any income tax or National Insurance contributions.

Example 2:

Duncan saves £125 a month into the Dunco AESOP. As a higher-rate taxpayer, he pays 40% tax and therefore receives £50 in tax relief (40% of £125). This means that his net monthly salary falls by just £75.

Duncan uses this £125 to buy 125 Dunco shares at 100p each. However, Dunco is a generous firm and gives Duncan two free shares, meaning that he now has shares worth £375 that cost him just £75.

Duncan buys shares out of every month's salary so, by the end of the year, he has bought shares worth £4,500 that cost him just £900 (assuming Dunco's share price stays constant for those twelve months). Between them, the Taxman and Dunco have boosted Duncan's contributions by a factor of five.

Duncan also knows that his shares will have to fall by over 80% before he starts losing money, so he's fairly confident he's going to make a pretty penny over the next five years. He now feels even more warm and cuddly about working for Dunco.

Although these schemes may seem fairly complicated, they're very much worth considering, thanks to the boost to your savings that your employer provides. Use them as part of your overall investment plan but not as your sole way of creating wealth.

There are other employee share schemes, which we will cover in a future article. This article provides some basic details on employee share schemes but different plans have slightly different rules, so do speak to someone knowledgeable in your company before investing.

Finally, if your employer doesn't offer any employee share plans, perhaps it's something you could raise with the management as a way of boosting staff retention, loyalty, motivation and commitment!

To learn more about employee share ownership, visit Proshare.