The hidden risks of save as you earn schemes

The value of BT shares unexpectedly plunged by 20.8 per cent on 24 January, following news of the company's accountancy problems in Italy. Similarly, a profit warning in January sent Pearson shares tumbling by some 30 per cent from 808p to 573p.

Among the many BT and Pearson shareholders whose holdings took a nosedive in value that day will have been thousands of employees of the companies who bought their shares through save as you earn (SAYE) schemes.

So how could they have mitigated the losses they have suffered? Are there lessons to be learnt by members of SAYE schemes generally?

The nuts and bolts of how employee sharesave schemes work

HOW DO SAVE AS YOU EARN SCHEMES WORK?

First introduced back in 1980, SAYE schemes, which are run by employers, allow employees to save anything from £5-£500 a month and purchase cheap shares in the company after a certain period.

So how do they work? Your chosen level of savings is deducted from your net salary each month. It is set aside in a designated bank account, where it earns interest at the level of a savings account over a term of either three or five years.

The scheme can help you build up a pot of savings, but the real bonus comes at the end of the term.

SAYE schemes include an option to buy shares in your company at a price set at the beginning of the scheme. This option price may include an additional discount of up to 20 per cent on the share price at that starting point.

They're a very tax-efficient way to save. Andrew Johnson, a money expert at the Money Advice Service, says: 'SAYE schemes typically run for three or five years, during which time you can save up to £500 a month.

'When the scheme reaches maturity, the tax-free interest and any bonus is added to your savings. You can then either choose to take all your savings as cash or buy shares at a fixed price agreed before the scheme commences.'

While your money is in the savings account, it is protected by the Financial Services Compensation Scheme, so if anything happens to the bank or building society holding your money, losses of up to £85,000 are covered.

If when your scheme matures your option price is higher than the current share price, you don't have to buy the shares: you can simply take the cash.

CONVINCING CONCEPT

The SAYE scheme is a great concept. Not only does a scheme encourage saving, but it fosters employee engagement by giving employees a vested interest in their companies.

The scheme has been designed to encourage participants to get into a regular savings habit by offering them the potential to realise a greater gain if they take the share option and then sell their holdings, or own a small part of the equity in the company they work for if they hold onto the shares as a longer-term investment.

If the current share price is higher than the scheme purchase price at the end of the scheme period, it's sensible to use your savings to buy shares at the lower price, says Scott Gallacher, a chartered financial planner at Rowley Turton.

'The risk comes if you do not then immediately sell those shares. As most people cannot tolerate, or perhaps afford, the risk of losing all their money should a company fail (think Railtrack, Enron and Marconi), they should not hold on to these shares.'

In this context, it is pertinent to ask how much guidance employees are given about the risks involved.

Gabbi Stopp, head of employee share ownership at ProShare, says many employers provide financial education for their employees and access to financial advisers who can help employees understand the risks of 'concentration' in their employers' shares.

However, Kieron Robertson, a chartered financial planner at Concierge Wealth Management, says the recent downturn in the share prices of firms such as BT and Pearson could be a sign that employees lack advice on the suitability of single-company holdings compared with diversified portfolios, on their appropriateness over time and on how such schemes relate to their needs, capacities and risk tolerances.

Simon Webster, managing director at Facts & Figures Financial Planning, however, argues that the risks with SAYE are low, even for BT shareholders.

Webster points to the fact that five years ago (February 2012) BT's share price was 216.5p, three years ago it was 277.10p and today it is 321.67p. He says that while it peaked on 27 November 2015 at 499.80p, 'who knows what the price will be in November 2017 or 2019?'

He adds that if you had been saving for five years until today, you'd have bought at 216.50 less 20 per cent and made about 85 per cent. Over three years you'd have made 28 per cent.

Even if the market had moved against you, you would have got your money back, so the only risk is loss of interest at about 0.5 per cent for three or five years.

He concludes that investment decisions - including the decision whether or not to sell SAYE shares and reinvest the money in something more diversified - should be guided by an investor's time horizon and attitude to risk as well as market conditions.

SINGLE-COMPANY RISK

Ian Morrison, a chartered fellow financial planner at Morrison Personal Financial Planning, gives an example that illustrates the extent to which employees may be exposed to single-company risk.

Among his clients are a couple who both work at BT. Their salaries are around £20,000 and £30,000.

Both have worked for BT for more than 20 years. Morrison says: 'They are very proud of BT and certainly feel a strong sense of loyalty to it as a supportive employer.

'They have about 85 per cent of their liquid wealth in BT shares, and the rest is in cash. They are not experienced investors, and they have only invested in BT shares as part of their SAYE options.'

Morrison notes that the scheme has been good for them, as they have made substantial returns on their long-term investment, but it seems to have skewed their views on investing.

He says: 'That to me is a danger. Clients in this position often do not fully appreciate the risk their [single-company] investment carries, yet they are unlikely to be persuaded easily that diversification should be considered.'

Charles Calkin, a financial planner at James Hambro & Co, says: 'Saving into a SAYE scheme will make a lot of sense for some people, but holding on to the shares when the contract matures is another matter.

'Yes, your company might grow and its share price soar, but you could find yourself holding a large chunk of your savings in the shares of the firm that is the source of your employment.'

He adds that no one is saying BT is about to implode, but he stresses that we have seen big names such as Northern Rock and Lehman Brothers tumble. Employees in those firms lost their jobs and their investments.

Calkin concludes that saving in a SAYE scheme can be a good idea, but holding on to a single-company shareholding in perpetuity after the scheme matures represents a concentration risk.

It's worth considering selling the shares and moving your assets into a diversified fund or portfolio that is in line with your attitude to risk.

SAVE AS YOU EARN SCHEME TAX RISKS

Johnson cautions that those in SAYE schemes should be aware of the tax risks these entail. They may have to pay capital gains tax (CGT) on any gain in excess of their tax-free allowance (£11,100 for 2016/17) when they sell shares.

Calkin says the end of the tax year is a good time to review old shareholdings. He comments: 'If you sell, you may be crystallising a gain and be liable for CGT. You have an £11,100 capital gains allowance up to 5 April.

'We are waiting for the Budget to find out what next year's allowance is, but if you have a large holding, you may want to sell in tranches either side of the tax year end. It's worth taking advice before you do anything, especially on the most appropriate place to invest the proceeds.'

He adds that those who have worked for a company for a long time, participated in a number of these share schemes and accrued a lot of shares, and are likely to find themselves exposed to CGT if they sell their shares could consider gifting strategies.

If you gift half your holding to your spouse before disposal, it can double your CGT allowance, says Calkin.

If your scheme matured fewer than 90 days ago, you can put shares (up to the Isa limit) into an Isa wrapper without incurring CGT on the transfer; you will then be free of CGT when you eventually come to sell.

Income from SAYE shares (unless in an Isa) will count towards your £5,000 tax-free dividend allowance.

Dividend income beyond this allowance will be charged at 7.5 per cent for basic-rate taxpayers, 32.5 per cent for higher-rate taxpayers and 38.1 per cent for additional-rate payers. Again, gifting half the shares to a spouse is a good way to double allowances.