SAYE Share Options: There are better deals out there
From 27th February 2011, the effective rates of interest on SAYE share option schemes are changing. The rates remain derisory, however. Meanwhile the schemes face other difficulties, namely overcharging by savings carriers and attack from unsympathetic accounting standards. There are better alternatives.
Under an SAYE scheme, employees can save up to £250 per month over three or five years. They can then either withdraw the proceeds as cash, together with a tax free bonus, or use the proceeds to exercise an option to acquire shares. The option price is the fair value of the shares at the date of grant, less a discretionary discount of up to 20%. If the value of the underlying share increases, so does the value of the option. In the past, some large schemes have generated profits of tens of thousands for lucky participants.
Miserly interest rates
Now, however, the SAYE scheme is under attack from all sides. For example, the tax free bonus at the end of a three year savings period is equivalent to interest payments of just 0.18% per annum. The five year rate is 1.1% per annum. These rates are insultingly low. The rate on a National Savings ISA, for example, is 2.5% tax free. Even premium bonds, legendary for their mean returns, offer a better deal. The effective interest rate on a Premium Bond today (taking account of your chance of winning) is 1.5% tax free.
More important, however, are the costs of running SAYE schemes. Only a few years ago carriers such as Yorkshire Building Society were offering to hold SAYE savings at no charge. Today, however, the major carriers will normally charge many thousands of pounds, and in some cases five figures, to operate SAYE schemes. This is fine for the large listed companies but a serious disincentive for smaller companies who otherwise would have been keen to offer employees the chance to acquire employer shares through saving.
Additional problems have been created by the accounting standard IFRS2. This requires companies to expense the economic value of share options against their own profits. For reasons that we previously discussed, the standard is wrong in principle and misleading in practice. The effects are particularly problematic for SAYE schemes. If employees are offered any discount on the exercise price, this is added to the amount to be expensed against profits. There are further problems if options are renounced, which commonly happens if a participant decides to withdraw their cash from the scheme and forgo the share options. Common sense might dictate that this would result in a reduction in the deduction from accounting profits. But IFRS2 takes a bizarre and contrary view. Where options are renounced early, the whole cost of those options must be taken as an accelerated charge to profits. Companies therefore suffer an additional disadvantage when savings are withdrawn.
Taken together, these are serious problems for SAYE share option schemes. Up to 20% of all companies who once offered SAYE schemes now no longer do so. This is unfortunate since, over the years, SAYE schemes have introduced large numbers of people to employee share ownership.
What are the alternatives? One obvious possibility for smaller companies is to offer options under an Enterprise Management Incentive (EMI) scheme alongside a savings contract. The employer simply deducts the savings amounts from net pay and lodges them with the bank. The proceeds are eventually used to finance option exercise. Aside from the costs of drafting the EMI scheme itself, the savings costs are negligible and employees should receive at least some interest. The option can be drafted in a far more flexible way than under SAYE.
For larger companies, or those who do not qualify for EMI, a similar arrangement can be achieved with an approved Company Share Option Plan (CSOP), although in this case options have a minimum three year term and cannot be offered at a discount to fair value at the date of grant.
Another possible alternative is the Share Incentive Plan (SIP). These schemes allow employees to purchase shares from gross salary, before deduction of tax and NI and if held in trust for five years remain completely tax free (all gains are tax free after three years). A SIP is potentially is much more tax-efficient than an SAYE scheme although the savings limit is lower, at £125 per month (or 10% of salary if less). Additionally, under a SIP, employees are not locked into long savings periods and can be offered free shares in addition to the ones they buy.
If you would like more information on any of the matters raised in this article, please call us on 020 8949 5522 and ask to speak to any of our advisers.