Note: This post was first published in August 2019 and updated in February 2021
Sometimes it seems there is nothing but obstacles on your road to financial independence.
Stagnating pay, high taxes, the ever-increasing cost of living, stock market downturns. Possibly some naughty habits as well.
Take your pick – all of these will all take a bite out of that nest egg you are so carefully building up.
And so, if you are serious about reaching financial independence, you need to use every single wealth-building tool you have access to.
Thankfully, there are schemes out there that are funded by either the government (gasp!) or your employer – or both – that can provide a boost to your savings.
Save As You Earn (also known as SAYE) is a scheme where your employer gives you shares for less than they are worth. This allows you to realize an instant boost to your net worth at the completion of the scheme.
As a helpful guiding principle in life, anytime someone offers you free money (and it doesn’t involve doing anything dodgy or illegal), you should pay attention.
Today, let’s do a deep dive on Save As You Earn and see how you can use it in order to reach financial independence sooner rather than later.
What Is Save As You Earn?
Introduced in 1980, SAYE is a mechanism that allows company employees to gain free share options with their employer.
At the beginning of the scheme, the employer sets a price at which the shares will be granted to the employees. This is called the option price and it is usually set at a discount to the prevailing market price.
That discount can be up to 20%.
The employees can then choose to contribute anywhere between £5 and £500 a month into the scheme. Sometimes the contributions are capped by the company.
For example, the SAYE scheme I had with a previous employer capped the contributions at £300/month.
The scheme lasts either 3 or 5 years. At the end of the scheme, the employee can choose to do one of the following:
1. Use the savings in the scheme to buy the shares
2. Take their savings as cash
If at maturity of the scheme your company’s share price is above the option price, you should buy the shares as you get to make an instant profit.
However, if the company’s share price has dipped below the option price, you obviously take your savings as cash and run for the hills.
In the event you leave the company before the scheme matures, you will be eligible to collect your cash but it is likely the company will ask you to forgo your share options.
If, however, you are made redundant, retire, or leave because of an illness – or if your company is acquired, it is likely you will able to exercise your share options.
Let’s run through a few real-life examples to see how this might work.
Richard works at Acme plc. He contributes £50/month into Acme’s Save As You Earn scheme, which gives him the right to buy Acme’s shares at a 20% discount.
At the launch of the scheme, Acme’s shares were trading at £10 and the option price was 20% lower or £8.
At the end of 3 years, Richard has contributed £1,800 to the scheme.
Acme is no Tesla, but its shares have gone up in price to £15.
Equally, Richard is no Warren Buffet, but he is an avid reader of personal finance blogs. Thus, he chooses to exercise his right to buy Acme shares at £8. He buys 225 Acme shares for the £1,800 in the scheme.
However, because Acme’s shares are now worth £15 apiece, Richard’s 225 shares are actually worth £3,375.
Richard made a tax-free profit of £1,575 or 87.5% on the SAYE scheme.
Kate works at Widget plc. She contributes £80/month to Widget’s SAYE scheme.
Widget’s share price at the start of the scheme was £5 and the option price was 20% lower or £4.
Over a period of 5 years, Kate ended up contributing £4,800 to the scheme.
However, Widget fell on hard times because of
Brexit / Covid / [insert yet another calamity here] and the share price is now £3. The Reddit traders aren’t riding to the rescue anytime soon.
It makes no sense for Kate to buy shares for £4 if they are only worth £3.
Kate collects her £4,800 in cash. No money lost, no hard feelings.
What Are The Advantages of Save As You Earn?
Unsurprisingly, there are a few.
Free option to make money with no risk
Because shares tend to go up in price over time, the potential gain is comprised of the discount granted at the beginning of the scheme and the gain in share price between the beginning and end of the scheme.
Because you can choose to take your savings as cash there is no downside (other than opportunity cost).
Your SAYE contributions come out of net pay which has already been taxed. However, the gain you make on the difference between the current share price and the option price is also tax-free.
You can also avoid paying taxes on any future capital gains if you purchase the shares and move them into an ISA or a self-invested personal pension (SIPP).
You should think twice before holding on to the shares, though (more on this below).
You can stop or pause your share scheme contributions but chances are that once you’ve opted in, you will keep going.
SAYE allows you to automate your savings by re-routing the contributions into an investment pot before they even hit your bank account.
The contributions you are making to the SAYE scheme are ringfenced and protected by the government’s FSCS scheme.
The limit is £85k which is more than sufficient given the maximum allowable contribution of £500/month.
Better employee engagement
The theory is that employee share ownership fosters employee engagement and contributions.
In theory, motivated and engaged employees are beneficial to the company’s bottom line which is, in turn, beneficial to the company’s share price.
Sounds Great So Far – Any Shortcomings?
Yes – a few.
First of all, the current rate of interest on your contributions to the scheme (which is set by the government) is zero.
This presents an opportunity cost versus other investment choices. With SAYE, there is always a chance that all you get at the end of the three or five years is just your cash.
Now, this isn’t an issue if you were to hold your cash in a savings account instead. Heck, it may even be an advantage if we ever get to the bizarro world of negative retail interest rates.
But to the extent you were going to invest the money in equities instead, the opportunity cost can be meaningful.
Secondly, depending on your individual situation you may be better off contributing to other schemes.
While a 25% potential boost to your savings is attractive, an additional rate taxpayer gets an instant 45%+ boost on any contributions she makes into a workplace pension (subject to the taper and LTA).
Alternatively, you could put the money into a LISA and get a 25% bonus.
Finally, there is the concentration risk of investing in your employer’s shares.
To mitigate said risk, you should probably sell the shares the moment you get them, realize the tax-free gain and invest the proceeds into your index fund account.
Should I Go For a Three or a Five-Year SAYE Scheme?
According to the FT, four in five employees are on three-year SAYE schemes.
In theory, you could realize a higher gain on a five-year scheme as the appreciation in your company’s stock is likely to be higher over five years.
Practically speaking, you need to consider both your employers’ prospects as well your expected tenure with the company.
I find five years to be a long time to stay at the same company and hence always opt for three years.
Is Save As You Earn Right For You?
Only one in three eligible employees utilize SAYE at the moment. So are 67% of the workforce missing a beat or is there more to it?
As ever, the answer is that it depends on your circumstances. In particular, your tax bracket and your age are two important considerations.
Your tax bracket
If you are a basic rate taxpayer, chances are that SAYE represents one of the best wealth-building options for you.
Assuming your company’s share price doesn’t decline, SAYE provides the same level of tax boost to your savings (25%) as contributions to your pension.
No, you won’t get the employer match or the national insurance benefit. But bake in some decent growth in the share price and SAYE could become even more attractive than making a contribution to your pension.
The math is slightly different for additional or a higher rate taxpayers. At either 40% or 45% marginal tax rates, the pension tax break alone would far outweigh the 20%+ boost from SAYE.
The gains from SAYE are realizable as soon as your scheme ends, which is in either three or five years.
You can only collect your pension starting at 55. If you are younger – and especially if you are looking to retire before you turn 55, a SAYE scheme could boost your non-deferred pot.
It may well be that after considering all of the above, you will decide that SAYE is not the right wealth-building vehicle for you.
But you sure owe it to your future, financially independent self to do the math.