25 Feb 2013, 6:15pm
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  • SIP and Sharesave Employee shares and Capital Gains Tax

    Now is the time to be thinking about capital gains tax, with the ending of the tax year. I have never had reason to be concerned about CGT before.  I’ve always done my stock market saving in ISAs apart from a rush of blood to the head in the dot-com bust. I do know one fellow who got into hot water at that time by making a shedload in the run-up, incurring a reasonable amount of CGT, which he struggled to pay because he, er, reinvested and got hammered in the bust. Ouch.

    Looming large is the accumulated detritus of decades at the coalface of The Firm, in particular the last ten years when I was trying to reduce my higher rate tax liability but wasn’t close enough to retirement to unleash the big bazookas of pension savings.

    If there’s one lesson to take away from this – Sharesave: Just Do It.

    I was always a fan of sharesave – nobody’s ever offered me a one-way bet on the stockmarket before or since, so I filled my boots.The trick with sharesave is to keep on turning up. Most of the time it’s a damp squib or a minor jolly down the pub, but every so often your boat comes in and you get a great one-way win on the stock market without eating the corresponding risk. Just do it, though how you do it depends on whether you can cancel previous schemes to get the lowest share price or have to spread yourself evenly across schemes. Many people get bored with the dry periods, it so happens that the boat came in just as I left The Firm – the profit on the last Sharesave is probably half of the total profit I made on sharesave while working there. In total over my career Sharesave paid me probably about a year’s final salary tax-free; over nearly twenty-five years working for The Firm that adds up to about a 4% pay rise across my working life.

    Obviously the statistics for another company will be different, what makes sharesave so unique is it’s a rolling one way bet on the share prices rising. You just can’t lose. Most people, sadly, saw no longer than the end of their noses, and having to do without £3000 a year out of post-tax pay for the first five years was too much to pay for the opportunity to jump at the chance of a 4% pay rise. After the first five years they can pay for succeeding Sharesaves from the proceeds of the first lot.

    To reduce HRT exposure as I crept into the HRT band I started with ESIP – a share incentive plan. You get to pay up to £125 per month into a share incentive plan, which immediately buys that much of shares in the FTSE100 firm I worked for. Later on they softened it to that I could make a lump-sum purchase of up to £1500 a tax year. This comes out of pre-tax pay, so as I was drifting into HRT it was the first obvious win. I got paid dividends on the shares as soon as I bought them, and had to hold for five years to avoid paying tax. I always religiously sold in the year after they came out of the embargo period, on the usual principle that as an employee you want the least additional exposure to the firm you work for, because if the firm has a hard time you get to lose your job and your savings at the same time.

    As the good people at Northern Rock or Enron discovered, for God’s sake don’t needlessly increase your strategic exposure to your employer while still employed with them. The tail risks are very nasty indeed. That’s obviously not what sharesave and ESIP are all about, but you have to watch your tail 😉

    The trouble with buying stock £125 at a time, is that the calculation for capital gains tax is really, really, hateful. Most of my gains are due to sharesave, buying at 70p and selling at about four times that. However, the pool of shares is polluted with all those itsy-bitsy ESIP purchases – in the round these roughly doubled, with dividend reinvestment and the 41% tax and NI bung added.

    I’ve only got shares in The Firm outside my ISA, so I will sell £10,000 of this lot this tax year, and a similar amount next year. Not all of that is a capital gain, of course, but mathematically the capital gain must be less than the annual CGT allowance of £10,600, and my disposal is of course less than four times the allowance too. One thing that was interesting from HMRC is that if you keep your shares in the share incentive plan until disposal there is no CGT to pay, however I was unable to work out if this applied to me as I don’t work for The Firm anymore. If you still work for the employer, and I know an awful lot of people at The Firm will have a big sharesave come out next year, assuming it doesn’t all go titsup, then it’s worth really understanding what HMRC mean here.

    Approved share incentive plans (SIPs) If you keep your shares in the SIP until you dispose of them, you will have no Capital Gains Tax to pay in respect of this disposal. If you keep the shares after you take them out of the plan and dispose of them later, your cost for capital gains purposes will be their market value on the date the shares leave the plan.

    It looks like if you sell your shares straight from the Equiniti SIP/Sharesave corporate nominee share scheme you don’t take a hit for CGT whatever the gain, but do please ask the Sharesave team because it isn’t 100% clear to me, but it might be useful to those of you still at the coalface 😉 They usually hold a Q&A teleconference just before maturity which may be useful to attend.

    Selling my part-holding will give me the problem of having the vilest asset class of all, cash, which is rotting daily by the devaluing charlatans at the Bank of England.

    My, doesn't he look handsome. He's still a thieving SOB who wants to destroy the value of cash as quickly as possible, despite his good looks and clean-cut image.

    My, doesn’t our new Bank of England top dog look handsome? He’s still a thieving SOB who wants to destroy the value of cash as quickly as possible, despite his good looks and clean-cut image. That’s why Cash is not King…

    A year’s CGT allowance is conveniently about the same amount as an ISA allocation, but I already have funds allocated to that, so I will probably switch the proceeds for something tediously boring but not cash, like 60% Vanguard Lifestrategy and 20% Vanguard Europe and 20% gold just to observe the disgusting brutality that QE will do to the pound. The CGT clock will start ticking again on these unwrapped shareholdings, of course, but at least it’s an easier calculation than 60 monthly ESIP purchases 😉

    This will still leave me with a lot of The Firm’s shares, but brought down to a more manageable amount of only a third of my total holdings. The Firm fits well into a HYP, so once I have finished loading my ISA with savings I shall bed-and-ISA those unwrapped residual holdings of The Firm over a couple of years

     

    19 Jul 2012, 3:57pm
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  • Sharesave and Employee Share Incentive Plan – becoming an ex-employee

    I’ve gone on about Sharesave before, and I was also an avid customer of the Employee Share Incentive plan, particularly as I was on my way to becoming an ex-employee 🙂 Both of these schemes are designed to foster share ownership among the proletariat. Being a lumpenprole, of course, I don’t get to establish the sort of holdings that can depose the CEO, but nevertheless, sharesave was a way to take a one-way bet on the shareprice from post-tax pay for up to £250 a month, and ESIP let me buy shares in The Firm from pre-tax income, and formed part of my plans to reduce my taxable income to below the tax threshold this year. It’s also surprising how much of a holding builds up over time, even in ESIP with it’s low permitted savings limit of £125 pcm as the rapacious hands of the taxman get held at bay. When I started saving in ESIP in the early 2000s that £125 allowance was worth a bit more than it is now. The £250 limitation on Sharesave is also ridiculous – my first Sharesave was in the 1990s, when that was more of a challenge, the real value of that savings allowance has halved since then.

    Up till now I’ve had a policy of outing ESIP shares as soon as practicable after the five-year embargo, on the grounds of minimising my exposure to The Firm – you don’t want to take a pasting on your shares at the same time as your employer makes you redundant, as former employees of Railtrack, Northern Rock and Enron can testify. I’ve also studiously avoided The Firm and its sector in my ISA, on the grounds that I have enough exposure through employment,  Sharesave and ESIP. However, The Firm fits into a HYP, and if it’s good enough for Neil Woodford’s top ten then it’s good enough for me once these special circumstances fall away.

    On becoming an ex-employee all these shares become unembargoed, and all of a sudden a great lump of these ESIP shares come lumbering out, tax-free. At the same time, one of the Sharesaves is due to mature. Ordinarily I’d have given the instruction to take the option and sell immediately, to minimise my exposure to my employer while taking the three times uplift in price on the option price. However, this time, I will take the shares as a share certificate, and try and shift this into my ISA. Sharesave shares are one of the few exceptions to the general principle that you can’t transfer shares into an ISA unless they come from another ISA. However, they do take up part of the yearly ISA allowance, unfortunately valued at the time of transfer rather than the original option price 😉 That helps with capital gains tax. Although I don’t want to liquidate all these shares or even most of them, I probably have to do something to avoid a serious hit on portfolio diversification.

    ESIP shares have to come out of the ESIP account but can only be transferred to a normal dealing account. All in all I will end up with nearly half of my total shareholdings in The Firm’s shares. The good news is that The Firm is a decent dividend payer, and indeed I get to more than double my stock market capital base, so I now have an annual income that roughly matches the dole. The bad news is that more than half of my shareholdings by value are The Firm’s shares. The firm is riding high at the moment for some reason, and I am losing hand over fist on my shorts, which is fine by me. I’ve acted much more like the fictitious Ermevator in that story in that I doubled up on the amount of ESIP shares I bought and slammed the brakes on selling ESIP shares as soon as it looked likely that I would no longer be an employee of The Firm.There seems to be something about leaving The Firm’s employment that makes me a lot less equity risk-averse, which is kind of irrational. I’m not yet ready to sign up to Ernst and Young’s Indian Summer and indeed have more feeling for Dr Doom’s viewpoint in that there’s a lot of incoming for the next year. Some things have got to get worse before they get better, and if Dr Doom gets his request of policymakers letting the bust work its way through the system like a dose of salts then perhaps there is hope for capitulation and then some resolution.

    I have to discharge those shorts or roll them over in September, however, I will hang on to them until The Firm’s shares go XD and the Sharesave scheme matures. The maturity notice did warn that so many of The Firm’s employees will be selling shares at the maturity and that it may take several days to sell all the options, so now is probably not the time to close the short 😉

    29 Feb 2012, 4:38pm
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  • Employee Share Options, model theory and the Greek/Irish Default Conundrum

    Looks like the Irish have gone and joined the Greeks in causing trouble in the Eurozone paradise. It’s coming up to the end of the tax year, and The Firm informs me I haven’t used my employee share options yet. Stands to reason as I didn’t expect to be working there in five years’ time. However, it’s come to my notice that if I retire I get to spring these ESIP shares free of tax and NI without holding for five years. Now I don’t know about you but I loathe paying tax, so I prick up my ears and wonder if I’m about to miss an opportunity to stop that B’stard George Osborne stealing some of the Ermine’s heard-earned cash.

    So what’s the Employee Share Incentive Plan about then?

    Somewhere in the distant past it was deemed A Good Thing if employees had skin in the game relative to the share price, that’s even lowly grunts like me that are about five layers of management down from The Board. And Hector the Taxman lets you buy these shares before tax and NI have been taken off. If you are a higher rate taxpayer then you save losing 42% of your salary. Now I would be a HRT payer but I hate people stealing my money so much I pay all the excess over the HRT threshold into my pension AVCs so I am a basic rate tax payer. So I get to save 32% on this. The catch is that you do actually get to buy the shares at the time of taking the decision, and the shares are then embargoed for 5 years, take ’em out before then and you get tapped for the tax and NI you saved. You are also exposed to share price volatility, and you do get the dividends. Which is nice, as The Firm isn’t a bad divi payer at all.

    What are the Risks and Rewards and How can I Mitigate them?

    Let’s assume that The Firm is reasonably okay priced relative to its historical PE. The yield is about 3.5%, but I’m only aiming to hold the shares for sub a year, though I may change my mind once I am no longer working for them as they are a reasonable component for a HYP, and if The Firm is good enough for Neil Woodford’s High Income trust and I have no other exposure to its sector then perhaps I should just hold.

    Rewards

    Depending on how you look at it, I pay £1020 of post-tax income to buy £1500 worth of shares, a gain of 47%. Or as I look at it, I started out with £1500 and stopped the taxman stealing 1/3 of it. Either way, a gain of £480. I can’t buy any more than £1500 of shares, that’s the rules. If The Firm or the market takes this sort of viewpoint then I get to take a slice of the upside, and also some reasonably good dividend yield. The implicit yield of The Firm is upped from about 3.5% to about 4.5 by the tax discount on purchase price alone.

    Risks

    If The Firm screws up and the share price goes down the toilet. It’s been known, worst case is it has been about a third of what it is now, but that was an exceptional cock-up that was perpetrated by some directors who wanted to pump the SP to get their options, then left before the SHTF. Can’t guarantee that’s not about to happen again, but cooler heads seem to be prevailing.

    Estimated Probability – 40:60 up 10% or down by 10%

    The Greeks and/or the Irish cause a huge ruckus that destroys the Eurozone. Another form of the SP going down the toilet, let’s say this slaughters the UK stock market by 50% of its value, and The Firm gets caught in the crossfire.

    These are the main risks we suffer from. I could also add general Black Swan risks, such as getting hit by a meteorite at 625 to 1 but that would be facetious 🙂 There is, of course, a chance the stock market may go for a second near death experience as in 2007 but that might as well be lumped in with my estimate of the chance of the Greeks/Irish defaulting.

    Estimated Probability of Eurozone crash (over the < 1 year holding period) 30%

    Mitigation strategies

    I could use IGIndex to short my shareholding, converting the volatile shareholding into a fixed cash holding (minus the cost of shorting, and the cost of dividends, but of course I would get the dividends to offset that)

    I will represent this choice as a fixed cost of 5% of the holding, ie £75. I get rid of the risks of the Greeks, or The Firm screwing up, but I introduce some risk of IGIndex, the counterparty, going titsup.

    Estimated Probability of IGIndex failing – 0.1%

    Modelling My viewpoints

    I joned the Model Thinking course called out by Monevator (vaguely at the behest of Charlie Munger ISTR). One of the lectures deal with Decision Trees, so I figured i would take this for a spin and see what it says I should do. My choices are to buy the ESIP shares or not, and to hedge them at IGIndex or not. There are three uncontrolled risks IMO – a Greek default halving the value of the shares (from analogy to what happened with the market in general with Lehmans), the possibly of The Firm being slightly overvalued IMO, modelled as a 40% change of the shares going up 10% as opposed to a 60% chance of them going down 10%, and the risk of IGIndex failing, which I put at 0.1%.

    Go with my Gut or Model It?

    My gut feeling was go for it, and probably don’t bother to short.

    I ran all this lot into something called TreePlan, from www.treeplan.com. This is an add-on for Excel, and works okay, though it handles like a greased pig on an ice-rink; it is all too easy to blow away a branch of the tree at a stroke, there is no Undo with that. But it does the job.

    The result was surprising

    The results of the decision tree calculation. Computer says take branch 1 and 2. Buy the shares and short them.

    So going with my gut would have sent me along the wrong track, slightly. Or I am not correctly quantifying my risk perception, either over-weighting the likelihood of failure or over-weighting the cost of failure. The costs of failure are pretty clear on this one, so I am probably either irrational or quantifying risk perception wrong.

    Let me for a moment slough off my white pelt and pretend I am Ermevator, picking up some of Monevator‘s world-view. He tends to be more chipper about the stock market and the prospects for its investors even when being downbeat. He’d be more neutral to the Firm’s SP, if anything favouring a slight uptick, that I have represented by shortening the odds on a 10% uptick to 55% to 45%. And he probably wouldn’t let me get away with a 30% risk of Greek default, on the principle that the politicians will probably muddle through. So I’ve dropped that as low as I can go, to a 10% risk.

    An Ermevator would probably buy the shares and find the 45% uplift provided by HMRC enough hedge against future downside risks.

    Computer says buy the shares and wing it.

    Interestingly, the difference in outcome isn’t all about the Greeks. Bear in mind that the time horizon for this exercise is less than a year, even I might concede that 10% is probably a better reflection of the Eurozone implosion risk over the next year than 30%. However, simply changing that in the top model doesn’t change the solution. It is only by being more optimistic all round, about both the Greeks and the Firm that the Ermevator’s path becomes favoured, ie hold the shares without shorting. So I need to reflect more on where I think The Firm’s SP is going to go, as well as collect more data on how much IG will charge to hedge this over about 9 months. I also need to refine my thinking inasmuch as it probably only makes sense to short the £1020 that I forego by taking ESIP, rather than the £1500 total stake. Which reduces my shorting costs by 30% and uncovers the value of 30% of the dividends.

    All in all a surprising result from Model Thinking, which has taught me quite a lot about my worldview and its ramifications, and that this decision which looked fairly simple has more wrinkles than meets the eye. Whether it is worth so much mentation over £1500 worth of shares is a different matter, but it’s nice to actually apply something you’ve leanred at ‘vitual university’ to a real-world problem within a week of learning it. Charlie Munger was right, the old dog, and a hat tip to Charlie, Scott Page/UoM and Monevator for helping me think smarter 🙂

     

     

    20 Jan 2012, 11:59pm
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  • How to Use Sharesave Save As You Earn schemes

    For this to be any use to you you need to be a worker drone in a company that is listed on the London Stock Exchange, and has a save as you earn scheme. In practice I think that means it’s probably  a FTSE100 firm.

    The idea of sharesave is to encourage employees to take a share in the company, all considered A Good Thing. They’ve been running for years, I recall my Dad doing these. If your company offers one, they are a no brainer, do it, do it now, and do it to the max (£250 per month), as long as you don’t go into debt and have cleared your consumer debts other than mortgage. Once you have five year’s worth of contributions, you get that one way bet at no extra cost. It’s rude not to take part in an offer like that 😉

    Caveat employer… don’t hold shares in your employer longer than you need to

    You should generally avoid holding shares in your employer other than as part of sharesave or share incentive plan (another wheeze like SAYE, without the one way bet but with big tax advantages). That is because if your employer falls on hard times not only do your savings take a hit due to the share price bombing, but you are more likely to lose your job. The only exception I can think of is if you believe your employer is likely to be bought by another company, which is usually terrible news for employees but can be associated with a share price hike. It’s still a long shot and there are better ways of preparing for redundancy…

    For a similar angle but from a bunch with more financial clout than me, see the FT on will you buy into the John Lewis economy on the hazards of over-exposure to your employer. Think Northern Rock when you fancy holding onto shares in your employer longer than you have to…

    What’s so good about sharesave?

    The reason sharesave is a no brainer is that it makes you the kind of offer you will never get anywhere else, a one-way bet on shares. The worst you can do is simply end up saving cash for three or five years.

    What happens is in any year you are offered the option to buy shares in three or five years time at a price fixed at near what it is now. You start a monthly savings plan for up to £250 p.c.m. post-tax allocated in any proportion to the three and five year schemes. In five years time if the share price is higher than the option you exercise the option and then sell the shares immediately, pocketing the difference. Obviously if it’s lower you don’t exercise the option, and say I’ll have my cash back thank you very much, with some interest added usually. In a slightly depressing observation on the financial acumen of some of my workmates, I’ve known some people exercise the option when it isn’t in the money, and that’s even after the firm has added a letter to the maturity note saying you should note you can buy the shares cheaper on the open market. There’s no helping some people 😉

    In the past it was easier because you were able to drop schemes where the option price was higher than the latest offering, but HMRC has stopped that wheeze, (No, they didn’t, just some accounting changes made it so letting employees do that cost the company. See this comment for details. If your company still allows you to drop a scheme and reallaocate the savings allocation to fresh schemes, then you want to read How to Use Sharesave Redux) so though you can drop a scheme you aren’t allowed to allocate that monthly allowance to later schemes until the original term is up. This means you need to think first before acting, to avoid stiffing yourself further down the line.

    How to play sharesave to best advantage

    First you need to ask yourself realistically how long you expect to be working for this firm. If it’s only for five years then buy the three year scheme for two successive years, £125 a month in year 1 and the same amount in year two (i.e. £250 in total in year two and three, then £125 in year four). However if you are looking at working there longer, then you need a plan.

    Diversification is still your friend with sharesave, even though you are only dealing with one share. What everybody seems to miss, is that you have two temporal periods (3 and 5 years) and the chance to sample the share price every year.

    What you don’t want to do is look at the option price for the two schemes in the first year, decide the 5 year scheme is cheapest, and lob your whole £250 savings into that. You want to maximise the diversity of your time-slots.

    Diversify your temporal risk

    You also want to maximise the amount of time you’re in the market, so if you are going to be a lifer in this firm (or even aim to work there for a decade) then buy £50 of the first year’s 5yr scheme, £50 of the next years 5yr scheme, and so on. After five years, your allowance for the first year’s scheme will come free as it matures, and you can allocate that to the sixth year’s SAYE scheme. If you sell as soon as your options mature, assuming they are in the money, then you will have the cash to allocate to your next allowance, so this one-way bet is now free.

    You can do that instead with the three year scheme, but your options will only be in the market for three years rather than five, which reduces the amount of time your cash is in the market exposed to that one-way bet.

    I simulated this using the FTSE 100 index as a proxy for a typical blue-chip firm offering a sharesave scheme.

    yearly Sharesave returns if the company followed the FTSE100 index

    yearly Sharesave returns if the company followed the FTSE100 index

    and the cumulative profits over a 20 year period:

    Cumulative sharesave profits over 20 years

    Cumulative sharesave profits over 20 years

    The cumulative profits understate things because of inflation, and it also shows the heady profits that were to be had from the stock market in years gone by, the fat years after the early 90s recession up to the dot-com boom, then the 10 lean years from the dotcom bust to now…

    The pattern is familiar, I made most of the money from sharesave in the years leading to the dot com boom, and very little in the decade after. Unfortunately there was corporate action for my employer in 2001 which means I can’t get a historical time series back to 1990. The ride was a bit more choppy than this graph shows, and sadly I didn’t realise that the 5 year schemes are so much more valuable than the three, so I did a mix of 3 and 5 years.

    Watch out for specifics

    The industry your employer is in doesn’t necessarily have the same statistics as the FTSE100. It’s likely to be a damn sight more choppy – I know my company is. So it may be worth simulating the last decade or so of price data for your firm. Here is the spreadsheet I used, exported to Google docs. There may be cyclical patterns in your company’s share price that make some of the assumptions break down. Having said that I’d have done fine running rolling five years sharesaves with my employer’s shares.

    Don’t go with your gut

    I learned something from writing this post. From a gut feeling, I had gone for diversifying the period, buying a mix of 3 and five year schemes. I had not realised until now the fact that the 5 year schemes give me more time in the market and how valuable that was.

    This may have been offset by the fact that for my entire sharesave career I was able to drop previous schemes where the option price was higher, and reallocate the allowance to the more advantageous sharesave scheme. HMRC disallowed that in 2009, so you won’t be able to do that. Now if you take out a 5 year sharesave scheme even if you stop saving you can’t reallocate that allowance until the original 5 year term is up.

    Responding to exceptional share price events

    My employer had a near death experience which resulted in some pretty nasty management practices. Previously I had assumed I was going to carry on working to 60 at that time, but one particular incident showed me I was unlikely to make the course, so I switched all effort into saving up to be able to retire early. This near death experience slammed the share price in 2009, so the option price on that sharesave was very low. Though I didn’t know if I would still be working there in 2012, I dropped every single previous sharesave and threw everything into that year’s sharesave, with half the money allocated to the 3-year and half to the 5-year scheme. Obviously I have to put a lot more per month into the 3-year scheme as you only have 36 months to buy your shares, as opposed to 60 months. The aim is to have an equal monetary stake at the end. This works out to £94 in the 5-year and £156 in the three.

    The principle is that you don’t know what will happen in 3 or 5 years time, so I want to bet on both horses. Say the Euro blows this year, then the 3 year options might lapse but the price on the option maturing may be lower. In that case don’t execute the option. There’s still chance for some of the storm to blow out and the 5-year option to come good. Although I don’t expect to be working there when the 5 matures, once the scheme has been running for three years then under some of the circumstances I may leave I could make it paid up.

    If the 3 year option matured tomorrow, I would do very well out of this sharesave, indeed I couldn’t liquidate the shares without becoming liable for capital gains tax, which would be a first for me. I believe that the Euro is doomed beyond redemption, and that the denouement could very well happen this year.

    So I have gone to IG Index and shorted half the number of shares I have options in. Barmy, you might say, why the hell short something I own, but that has the effect of locking in half the options at the current price. If they go down I make a profit at IG to compensate, if they go up I have to pay IG but I get more selling the options. I’m prepared to pay that as insurance. In three month’s time I will short half the remaining half, assuming it makes sense, to lock in the price for three quarters of the shares.

    Spread betting comes with an extreme wealth warning, but it’s the right tool for the job here. Another case where you may want to short a stock you hold is to avoid eating a capital gains hit. Just carry on holding the shares and short them, buying the short and the number of shares you own / 100 (because IG prices move £1 for every penny the share price moves, with you rescale back but selling 1/100th of the amount). If nothing untoward happens I may have to do that in August; sell half the shares to avoid the CGT liability and roll over the IG short on half the total which I will still hold, eliminating my exposure to my employer without selling the entire stake.

    Spread betting works for the tax-free employee share incentive plans too. With these, you buy up to £125 of shares from pre-tax and NI income, which you have to hold for five years before you can sell.

    Sadly, this is another trick I missed, so some of the shares I hold went through the near-death experience, though they’ve come back up. I could have shorted thse guys as I bought them every month, taking the tax-free bump up and protecting my purchase against the vagaries of the stock market. However, it just goes to show one of the dirty little tricks of capitalism. By the time I got experienced enough to spot this insurance scheme, I’m about done with the opportunity to use it. As a colleague once wryly observed, money is drawn to money…

     
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