Signing up to an annual direct debit payment plan from your energy supplier is supposed to help prevent bill shock as your payments are spread equally throughout the year. But it might not work like that...
The UK's best 'secret' savings scheme
Image: David Jones - PA Archive
Nick Clegg has revealed his plans to create a "John Lewis economy" that would radically increase the level of employee share ownership amongst UK workers.
Basically, the idea is that companies that are partially employee-owned will perform better and thus boost economic growth.
But the concept of share ownership isn't only beneficial to the wider economy - indeed, it can offer a healthy alternative for hard-pressed savers. Here, we'll take a look at an often-overlooked scheme that can offer remarkable returns with limited risk. In fact, I know of one particular plan that has turned £9,000 saved over 10 years into a mighty £45,000.
But before we get to that, here's a bit of background information.
Savings rates still low
The past three years have been the toughest in history for Britain's increasingly stressed savers as the base rate has remained at its record low.
With the best interest rates paid by savings accounts at most 3-4% a year, some savers have been willing to put their capital at risk by buying high-income shares. Then again, stock markets have been highly volatile since 2007, which makes them no place for the cautious.
So far in 2011, the FTSE 100 index of elite companies is down around 8%. This means that many investors in shares have lost money this year, even after factoring in dividends (the income from shares).
One amazing alternative
Given low savings rates and unstable share prices, what can savers do to earn high returns, but at relatively low risk? Take a look at this special savings scheme that involves buying shares monthly while getting generous kickbacks from the taxman.
In fact, I reckon that this is one of the best available, despite being largely unheard of among UK savers.
Taking a sip of SIPs
This little-known, but widely available, savings plan is known as a SIP, which is short for Share Incentive Plan.
The 'Share' in SIP tells us that this scheme involves buying company shares. Therefore, the UK's six million public-sector employees cannot contribute to this scheme, nor can self-employed workers.
Then again, workers at private companies with shares listed on a recognised stock exchange can participate. Also, smaller, unlisted companies can set up SIPs, despite the lack of a ready market for their shares.
Alas, though SIPs have been around since mid-2000 and are open to millions of savers, they are not yet as popular as other work-based savings schemes such as Save As You Earn (SAYE, also known as Sharesave).
The latest survey of SIPs by the organisation IFS ProShare revealed that, in 2010, there were 890 SIPs in place, costing the government £320 million a year in tax bungs. What's more, although SIPs are all-employee schemes open to an entire workforce, nearly half (44%) of workers don't contribute to their workplace SIP.
In short, there are roughly a million SIP savers, but there is plenty of room left on this savings bandwagon...
How SIPs work
There are three types of SIPs on offer, with companies free to 'pick and mix' these as they see fit:
1. Free shares
Employers can give free shares worth up to £3,000 a year to employees, free of income tax and National Insurance (NICs). Up to 80% of the shares awarded can be based on individual, group or company performance against targets.
Given that these shares are completely free, they are obviously the cheapest investment to own.
2. Partnership shares
Employees can buy shares from their pre-tax weekly or monthly wage, up to a limit of the lower of £1,500 a year or a tenth (10%) of salary. Alternatively, employees can invest a yearly lump sum of £1,500.
Again, these shares are free of income tax and NICs, which means that a monthly contribution of £125 can cost as little as £60 a month (for high earners paying 50% income tax and 2% NICs).
For those paying basic-rate (20%) tax and NICs at 12%, saving £125 a month deducts just £85 from take-home pay, with the taxman chipping in £40.
Here's a summary of the cost of contributing £1,500 a year to a SIP, based on three different tax levels:
|Effective tax rate||32% (20% tax+12% NICs)||42% (40% tax+2% NICs)||52% (50% tax+2% NICs)|
Hence, the big advantage of this savings scheme is that HM Revenue & Customs chips in £480 to £780 a year in tax relief, depending on your tax band.
3. Matching shares
Employers can match each partnership share bought by employees with up to two free shares. Thus, a before-tax contribution of £125 a month can buy shares worth up to £375. In effect, the best matching shares SIPs can triple your money on day one.
According to IFS ProShare, more than half (53%) of employers running SIP schemes also hand over matching shares on top.
More tax breaks
As well as the tax relief on contributions, SIP savers enjoy a few more tax breaks.
Any dividends paid out on shares bought via SIPs can be reinvested into more shares, but these dividend shares are limited to a maximum of £1,500 a year. Any dividends in excess of this limit are paid to the shareholder and taxed in the normal way.
All free, partnership, matching and dividend shares must be held inside the SIP for at least three years or the tax relief granted on purchase will be clawed back. If withdrawn between three and five years, income tax and NICs are due on the lower of the salary used to buy the shares and their market value at the time of removal.
However, after being held for five years, then all SIP shares become completely free of tax. From this point, they can be left to grow, tax-free, inside the plan or be withdrawn, also tax-free. Also, there is no Capital Gains Tax liability when shares are sold inside, or withdrawn from, a SIP.
Therefore, for the maximum tax breaks, you should keep hold of SIP shares for at least five years. Also, if you're forced to leave your employer due to disability, redundancy, retirement or death, then all SIP shares can be withdrawn tax-free.
Start SIPping today
My wife works for a multinational company with perhaps 100,000 employees. She joined her employer's SIP as soon as it opened in 2001, paying in the maximum £1,500 a year. Thus, over the past 10 years, she's bought shares worth around £15,000.
However, tax relief on these contributions cuts the cost of these shares to roughly £9,000. In addition, this SIP is a BOGOF (buy one, get one free), so my wife actually bought £30,000 of shares.
Despite her company's share price jumping and slumping in the stock-market roller-coaster of the past decade, these shares are worth roughly £45,000 today. Where else could you have turned 120 monthly contributions of £75 into such a hefty sum in the past 10 years? Probably not by giving your money to a fund manager.
In summary, SIPs are a tax-efficient, relatively low-risk method of saving. If you have one at work, then I'd urge you to join it today. Just make sure that you sell some shares now and then, or you could be at risk if your employer gets into difficulty!
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I had shares in a bank.... Northern Rock. Now I have had them taken away from me by the Government and the bank handed to Richard Branson for a very "sweet" price.
Now I go to the bookies.. I don't win a lot but the bookie is my friend and buys me a pint every now and then... and he doesn't look for ways of nicking money back when I win.
I did have savings in another bank... that was RBS. Now apparently me and my working friends own 84% of that one... yet still I see no return on my money either in interest on my account or interest on the massive amount used to subsidise the Bank.
After reading this article, one would think that the 'money' grows on trees.
The only person who can tell you about what to do with your finances is YOU, and YOU alone.
I feel really sorry for the new generation, who are brain washed into buying all these silly
gadgets, which needs continually upgrading and thus are hooked into expensive monthly contracts. Remember, nothing is 'free' in life, irrespective what they say, and like the old saying,
'every penny counts'.
remember when we got a little brown envelope every week withour wages inside then the boss said you cant do that anymore cos the government is to force you to be paid at the bank....note forced to not asked. I didnt have an account except at the post office so now the banks control us all! Progress? huh I want my money under my mattress to spend as I see fit not for the banks to keep making interest on every month and we get none of it. So the government are in it with the banks and have been for many years who are they kidding. How many billions of our money can be averaged as being with the banks over a year and how much do they make on our wages.
talk about George Orwell we are a number a bank number!
no-one said this should be the only savings you should have alan. The example was saving just £75 a month to get £45,000. Seems good to me! You could then spread your risk elsewhere with any other spare cash you have so should be fine. Obviously its worth cashing them in asap once you've avoided the tax issues, so you can spread the risk then too and keep on investing into new SIPS and SAYE's.
(PS I've had SIP and SAYE schemes both of which are VERY good! SAYE in particular).
I think this approach is rather risky, "eggs in one basket"!; but then putting your money in a bank account is not a good idea either as its the only investment guaranteed to help your capital erode to inflation. People are worried about investing at the moment, but I say this is the perfect time to invest; but go and see a regulated adviser before you do so.
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