Is that your nest-egg ticking?

More than three million workers are in some form of company share scheme. They can be very lucrative. But beware! They can also turn out be a tax timebomb

Harvey Jones
Saturday 16 September 2000 00:00 BST
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This month, asset management group Schroders has announced a new share scheme for employees worth £30m. A five-year save-as-you-earn scheme from HSBC, which matured in August, gave minimum handouts of £16,000. Some staff received more than £80,000.

This month, asset management group Schroders has announced a new share scheme for employees worth £30m. A five-year save-as-you-earn scheme from HSBC, which matured in August, gave minimum handouts of £16,000. Some staff received more than £80,000.

David Hanratty, investment planning director with Nelson Money Managers, says many staff receiving big payouts from employee share schemes are in quite junior positions. When their schemes mature many find themselves sitting on what he calls "a tax timebomb".

Each year thousands of employees take the gains on their share schemes only to see a capital gains tax bill blow up in their face. Many are reduced to tears when they realise that their returns have been slashed. "We regularly see very upset people who have been landed with a tax bill of nearly £3,000 that could easily have been avoided with careful planning," he says.

Estimates suggest that more than three million employees are members of share schemes. This number should grow under the new All-Employee Share Ownership Plans (Aesop). This new scheme allows employees to receive shares worth up to £7,500 each tax year, and roll up a further £1,500 in dividends. You pay no tax if you hold the shares for more than five years.

However, three existing share schemes, covering millions of employees, may attract a capital gains tax bill, and you need to plan carefully when the time comes to sell.

Hanratty says the two most popular current schemes are profit-sharing and save-as-you-earn (SAYE) share option schemes. Approved profit-sharing schemes are soon to be phased out and no new schemes can start after April 2001. But existing schemes, which cover up to a million employees and are worth hundreds of millions of pounds, may run for a further 12 months from that date.

SAYE schemes are not being phased out and new schemes may still be launched. Under the scheme employees save between £5 and £250 a month, over a period of three or five years. At the end of this period they have an option to purchase the shares at a price fixed at the outset, which can be up to 20 per cent lower than market value. Those who decide not to buy will get their original cash plus a bonus equivalent to prevailing interest rates. SAYE is more widespread than profit sharing, with more than a million members holding shares worth in excess of £3bn.

Hanratty says members of both types of existing schemes regularly fall foul of tax rules. "The employees are not fat cats, but often quite junior staff, with no experience of capital gains tax, " he says.

Everybody can realise capital gains of up to £7,200 each year without incurring a tax bill. Married couples can double this figure by combining their allowances, providing assets are held jointly. But any profits from employee share schemes above the capital gains tax exemption threshold will be taxed at either 10, 20 or 40 per cent, depending on your band.

You can protect a further £7,000 from the taxman using your individual savings account (ISA) annual allowance. Unfortunately, Hanratty says many people blow the opportunity of using their allowance by buying an ISA - encouraged by massive advertising campaigns by banks and building societies - shortly before selling their employee shares.

"The big providers like to use ISAs to sell their products. Unfortunately, nobody points out they are also an excellent facility for protecting employee shares from tax," he says.

Put just £1 in a mini-cash ISA sold by a bank or building society and the amount of employee shares you can shield from tax falls to £3,000.

Invest that £1 in a stocks and shares maxi-ISA sold by a fund manager such as Aberdeen, Gartmore, Fidelity and Jupiter, and you will not be able to protect a penny of your share scheme gains. "Many employees kick themselves when they realise what they have done," Hanratty says.

Some financial advisers neglect to notify their clients of the dangers, because they have a vested interest in selling ISA products. They get nothing if ISAs are used to shelter clients' share returns.

If you have a regular savings ISA plan and are likely to cash in employee shares next financial year, make sure you cancel your ISAs subscription before the April 5 2001 deadline. But make just one ISA contribution after that date, and you will lose next year's allowance.

John Whiting, tax partner with Price Waterhouse Coopers, says employee share schemes are hugely attractive, particularly with "capital gains tax housekeeping".

"You only incur tax when you finally sell the shares.," he says. "If you are likely to pass the capital gains exemption threshold, sell some shares this year and more the next."

Chislehurst-based financial adviser Brian Dennehy says planning the best time to take your employee shares can be complex, and speaking to an accountant could save a tax bill.

He says that employees should consider spreading their money with different companies, but gradually. "It is better to top slice the income you receive each year and use that to fund an ISA," he says.

If you think your company has an excellent future, stick with it. You will know best how strong its prospects are.

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