The best savings plan in Britain!

Would you like to save over several years, earn a tax-free bonus, buy shares at a big discount and avoid market crashes? Alas, not everyone can join this super scheme...

This classic lovemoney.com article has been updated for 2010.

I’ve been investing in shares since I was an eighteen-year-old student. The first full-blown stock-market crash which I experienced began with Black Monday, 19 October 1987. By the end of that month, my portfolio was down about three-tenths (30%), wiping out a year’s supply of beer from the Student Union.

The second big bear market (when share prices fall steeply) I survived was the crash from January 2000 to 12 March 2003, when the blue-chip FTSE 100 index more than halved. Through careful stock-picking, I fared quite well during this period. Alas, the latest crash has spared no victims, so I have lost a vast sum. Oops!

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Save with SAYE for a no-lose guarantee

Hence, wouldn’t it be really great if you could invest in the stock market without worrying about losing money? Actually, you can, through a savings plan called SAYE - Save As You Earn - also known as Sharesave.

SAYE is an employee share plan, which means that it’s not available to public-sector workers. However, if you work for an organisation that has shares which are traded on a recognised market (often the London Stock Exchange), then your employer may invite you to subscribe to SAYE.

Usually, you’ll be invited to join a SAYE plan once a year. By doing so, you agree to save a set amount - from £5 to £250 a month - for three, five or seven years. At the end of this period, you receive a fixed, tax-free bonus on your savings. This bonus changes from time to time - here are the current interest rates: three years - 0.54% pa, five years - 1.42% pa and seven years - 1.84% pa.

There's no question that the rates payable have come down sigificantly in the last two years which may make SAYE schemes appear less attractive. But this is indicative of the current savings market in general.

That said, SAYE is far more than just a boring old savings plan with less than spectacular rates. It also gives you the right, but not the obligation, to buy shares with your savings pot. In financial terms, this is known as a ‘share option’. What’s more, these shares can be bought at a discount of up to a fifth (20%) off the market price when your plan begins.

Of course, if the share price has plummeted during the life of your plan, then you simply grab your cash and walk away. However, if the market price is higher than the ‘strike’ price of your option, then it makes sense to buy the shares. Let me show you how Sharesave works, using a simple example:

• You decide to save £100 a month for five years, a total of £6,000 over sixty months.
• You receive a tax-free bonus of 2.6 times your monthly saving, which is £260
• You now have £6,260, which you can take in cash or use to buy shares.
• When you signed up to SAYE, the market price was £1 and your discounted price was 80p.
• The market price after five years is, say, £1.20.
• You use your £6,260 to buy 7,825 shares at 80p, then immediately sell them for £1.20 for an instant 50% profit.
• So, SAYE has turned your £6,000 saved over five years into £9,390 This yields a profit of £3,390 or 56.5% tax free!

SAYE really comes into its own when share prices soar or collapse while a plan is running. For example, during one five-year plan, my wife saw her company’s share price triple. As a result, she turned £250 a month turned into nearly £50,000! Likewise, when her employer’s share price dived during the 2000/03 bear market, Mrs D was able to collect her SAYE cash and avoid this market collapse.

One final word: if you build up a big stake in your employer using SAYE and/or other employee share plans, then make sure that you don’t have too much of your wealth invested in this one employer. As employees of failed FTSE 100 firms will confirm, the collapse of your company can have a devastating effect on your personal wealth. So, be sure to spread your money around - or watch your eggs and their basket like a hawk!

If you're not sure whether SAYE is for you, why not ask the lovemoney.com community what they think using our excellent Q&A tool.

More: 16 super savings accounts | Two simple ways to invest better in shares