Long-Term Incentive Plans (LTIPs) are a powerful tool for companies to reward key employees, aligning their interests with the company’s growth objectives. These plans typically involve offering company shares, which vest over time, as a way to incentivize high performance and retain top talent. If you’ve been granted an LTIP, it’s important to understand how it works, how it’s taxed, and how to manage the risks associated with holding company shares.
What is an LTIP?
A Long-Term Incentive Plan (LTIP) is a compensation structure used by many large companies to reward employees, typically executives, with company shares. These shares are usually subject to vesting schedules, meaning they are not immediately available but can be accessed after a set period. LTIPs are often used by FTSE-listed companies and multinational corporations as part of their executive compensation packages, designed to retain talent and encourage long-term growth.
Taxation of LTIPs
LTIPs are taxed differently at various stages: when the shares vest, when they are sold, and based on the profits you make from their sale.
When the shares vest, their value is treated as income, subject to income tax and National Insurance contributions (NIC). However, after the shares vest, they become yours. If you decide to sell them later, any profit made from the difference between the sale price and the vesting price will be subject to Capital Gains Tax (CGT).
- Income Tax: This is due at the time the shares vest, based on their value at vesting.
- Capital Gains Tax: This applies when you sell the shares, and only on the gain you’ve made since the shares vested. A £3,000 annual CGT allowance is available, meaning if your gain is less than this amount, you won’t pay any CGT.
The rates for CGT are 18% for basic-rate taxpayers and 24% for higher-rate taxpayers.
Example of LTIP Taxation
Let’s look at an example to see how taxes apply when an LTIP vests and when the shares are sold later.
Stage 1: Income Tax and NIC on Salary
Assume your salary is £250,000, and the LTIP award is 50,000 shares, with a company share price of £10 per share at vesting.
- Salary: £250,000
- Tax: £93,675
- NIC: £8,770
- Net Income: £147,555
Stage 2: Income Tax and NIC on Salary + LTIP
When the shares vest, you’ll now include the LTIP value of £500,000 in your total income:
- Total Income: £750,000 (£250,000 salary + £500,000 LTIP)
- Tax: £318,675
- NIC: £18,518
- Net Income: £412,806
Stage 3: Selling the Shares (Capital Gains Tax)
Let’s say the share price increases by 10% over two years, from £10 to £11 per share. When you sell the shares, the capital gain is taxed as follows:
- Sale Price: £550,000 (10% increase)
- Capital Gain: £50,000
- CGT Allowance: £3,000
- Taxable Gain: £47,000
- CGT Due: £11,280 (24% of £47,000)
- Net Income from Sale: £535,720
Managing Risk: The Importance of Diversification
While it may be tempting to hold on to your vested LTIP shares, doing so can expose you to significant risks. Having a large portion of your wealth tied to your employer’s stock can be risky, especially if your company faces financial difficulties or leadership changes.
To mitigate this risk, it’s advisable to diversify your investments. This can be done by selling some of your vested shares and using the proceeds to invest in a more diversified portfolio. Consider investing in global equities, bonds, or cash savings. This approach can help protect you from company-specific risks and provide more stability for your overall financial situation.
Ways to Invest Your LTIP Funds
Once your LTIP vests, there are several ways to use the funds to grow your wealth:
1. Contribute to Retirement Savings
You could contribute your LTIP proceeds to tax-efficient retirement accounts like pensions or ISAs. This strategy will help reduce your tax liability while ensuring that your retirement savings grow over time.
2. Build a Diversified Portfolio
Consider building a diversified portfolio with a mix of stocks, bonds, and other assets across global markets. This strategy spreads risk and ensures a more balanced approach to wealth accumulation.
3. Set Up an Emergency Fund
Using some of your LTIP funds to establish or boost an emergency savings fund can provide security in case of unexpected expenses. It’s always a good idea to have a financial cushion to rely on when unforeseen costs arise.
Conclusion
Long-Term Incentive Plans (LTIPs) are an effective way to reward employees and align their interests with the company’s long-term goals. However, understanding how they are taxed and managing the risks involved is crucial for making the most of your LTIP. By diversifying your investments, strategically using your LTIP funds, and seeking professional financial advice, you can maximize the benefits of your LTIP and build a secure financial future.