Financial advisers have unearthed a way for investors to boost their
retirement funds by claiming back an incredible 156 per cent in tax relief.
The strategy, which is open to more than 5m people, is one of the outstanding
perks of the pensions regime introduced in April last year.
The idea centres on investing in an employee equity scheme such as a “share
incentive plan” or a save-as-you-earn (SAYE) scheme. These work in different
ways but both allow staff to buy a stake in their company using pretax
earnings.
After several years you take the shares and then move them into a pension to
get a second tax rebate.
Millions of people who work for firms that offer the employee schemes —
including Barclays, Orange and Tesco — could take advantage of the ploy in
order to kick-start their savings with hundreds of pounds from the
government.
Claiming the double helping of tax relief can boost an initial contribution
into an incentive plan by 156 per cent if you are a higher-rate taxpayer,
according to figures from Scottish Widows, the insurer.
It works like this. The incentive plans allow you to buy company shares from
your pretax salary using up to £1,500 or 10 per cent of your income a year,
whichever is the lower.
Ignoring any increase in value, a £1,500 contribution costs a high-rate
taxpayer only £885 with income tax and National Insurance relief.
After five years you can sell the shares free from capital-gains tax (CGT),
and then place the proceeds in a pension, thereby claiming tax relief on the
contribution.
You are also able to move the shares directly into a pension, but will have to
open a self-in-vested personal pension (Sipp). Standard personal and company
pension schemes are not allowed to accept direct investment of shares.
The government pays 22p for every 78p you invest in a pension, taking the
total contribution to £1. So £1,500 is immediately boosted to £1,923.
Higher-rate payers get a further 18p through their tax return, or £346 in this
case. So a contribution costing £885 is turned into £2,269 — a 156 per cent
uplift.
To keep things simple, this example takes no account of any increase in the
share price.
It also ignores the fact that in incentive schemes your firm can give up to
two free shares for each share you buy, as well as £3,000 worth of free
shares in any tax year.
Once these are factored in, the returns can be astounding. For instance,
higher-rate taxpayers whose shares are matched two-for-one by their employer
and increase in value by 7 per cent a year could see a mouth-watering return
of up to 979 per cent on their original investment, boosting your initial
£885 to £9,548.
There are complications, though. The fifth anniversary after which the
incentive-plan shares become tax-free is based on the date when you bought
them.
Many people buy such shares on a monthly basis, which means you may not be
able to sell or transfer them all in one go.
About 2.6m people who are saving into the SAYE or Share-save schemes can also
benefit from double tax relief using this strategy.
SAYE schemes are generally considered safer than incentive plans, simply
because you do not buy the shares until the end of the term, so you are not
taking on any stock-market risk.
With incentive plans, however, your contribution immediately buys your company
shares, and if the stock nosedives your portfolio will take a hit.
Under the SAYE plan you can pay between £5 and £250 a month into a savings
scheme from your pretax earnings for three to five years.
At the end of this term savers receive a tax-free bonus, now worth between 2.5
per cent and 3 per cent.
You then have six months to decide whether to buy shares at a discounted rate
fixed at the start of the contract, take the cash and the bonus, or opt for
a mix of both.
Shares bought using an SAYE scheme are allowed to be transferred into a
pension within 90 days of the share option being exercised.
Although the strategy has been possible since April, few people have taken
advantage.
Many employee share schemes are only just approaching their three or five-year
anniversary, after which they can be transferred or sold tax-free.
If you sell before then, you may have to pay income tax and national insurance
contributions on the proceeds.
Many Sipp providers have been fighting shy of allowing direct investment from
an employee share plan because of the hassle involved.
But in two weeks’ time, Halifax Bank of Scotland, in conjunction with AJ Bell,
a Sipp provider, is due to launch a pension scheme specifically for people
who want to make a transfer from one of these schemes. Killik, a
stockbroker, is also planning to launch a similar scheme during the next few
months.
Investors need to watch out for charges. Within the share plans employers bear
the costs, but in a pension you would be expected to pay management and
administration fees.
There will be no set-up fee when you transfer shares into the Halifax Sipp.
However, the quarterly management charge will be £18.75 on up to £50,000.
Above that, the fee rises to £37.50.
If you transfer shares directly into the pension, you can sell them at a later
date tax free.
However, when you buy and sell shares there is a dealing charge of £11.95.
It is also possible to transfer up to £7,000 worth of shares from the plans or
SAYE schemes into an Isa, provided you have not used up some or all of your
annual allowance.
You do not get tax relief on the contribution, but on the other hand, income
and profits which are generated in the Isa are tax-exempt.
Isas are certainly more flexible than pensions because you have the option of
cashing them in at any time.
Profits made within a pension are tax-free, but you cannot access the cash
until you are 50, rising to 55 from 2010, and when you eventually draw an
income it is taxed.
THE SCHEME
- Take out an employee share plan. They take various forms, but typically
allow you to invest in your company’s shares using pretax earnings.
- With a share-incentive plan you need to wait five years after you have
bought or received the shares before they become completely tax-free. SAYE
schemes have a term of three or five years. Once you have secured the tax
benefits, sell the shares and invest the proceeds in a pension. Or you move
the shares from the employee plan directly into a Sipp.
- You receive tax relief on the contribution and leave it in the pension to
grow.
