If you are awarded options under the Long-Term Incentive Plan (LTIP) you may be wondering what these are and how they work. It’s important to understand as although these are taxed to income and national insurance there can be a bit of flexibility as to when you pay this, which can lead to some planning opportunities.
First of all, the LTIP awards are different to salary and bonus. Instead of cash you are granted a number of nil cost share options in Phoenix Group. A share option allows you to buy shares in Phoenix Group and the nil cost means you acquire these at no cost to you. However, you must wait 3 years from the date of the award being granted until these vest (i.e. until the options are available for you to use). This period is extended by a further 2 years for members of the Executive Committee.
The value of these options will rise and fall over that time dependant on the Phoenix share price. It’s also important to note that the number of options you are granted is unlikely to be the number of options that actually vest after 3 years. This is because the number of options that ultimately vest are influenced by 6 performance conditions of Phoenix Group. Your personal projections will be shown assuming 55% of shares granted actually vest (an industry standard) but the actual amount can vary by quite a lot either side of this depending on the performance of Phoenix Group – you’ll have a higher outturn if Phoenix meets its conditions, or less if not. There is no tax when the options vest.
Once vested, you then have 7 years in which to exercise the option (i.e. to buy the Phoenix shares). It is at this point you are subject to income tax and national insurance. For example, if you held 1,000 options and the Phoenix share price was £10, your options would convert into 1,000 shares with a value of £10,000 pre-tax. The £10,000 is then subject to income tax (45% in England) plus national insurance (2%), meaning a post-tax amount of £5,300 in Phoenix shares. You have a couple of options when you exercise the shares:
- •Exercise and immediately sell – This will exercise the options and immediately sell the shares. Using the example above, you would receive £5,300 into your bank account.
- •Exercise and sell to cover – This will exercise the options and sell enough shares to pay the tax. Using the above example, you would sell 470 shares and be left with 530 Phoenix shares worth £5,300.
- •Exercise and hold – This will exercise the options and hold all the shares. You will need to pay the taxes directly with Computershare. Using our example, you would pay £4,700 in taxes to Computershare and be left with 1,000 Phoenix shares valued at £10,000. If you choose to retain Phoenix shares you will then be subject to capital gains tax rules on future disposal. You will be deemed to have obtained the shares at cost. Carrying on our example from above, your base cost under the 2ndbullet point would be £5,300 for the Phoenix shares. If you sold the shares at a later date for more than this you will be subject to capital gains tax rules.
At the beginning we said it may, in certain circumstances, make sense to delay exercising the options. There are two main circumstances when you should consider doing this:
- •You will have a lower income in the next tax year compared to the current one – This could be because of reducing your hours / responsibilities or your cash bonus was larger than expected this tax year. It could be useful to defer exercise until the following tax year to control your adjusted net income and retain a larger pension annual allowance (see our article on high income issues)
- •You think the Phoenix share price is undervalued and will rise – In this scenario, you should consider retaining the option and not exercising until you feel the share price is fairly valued. Using the example above from above, if you felt the correct share price for Phoenix was £20, the difference between exercising immediately and delaying is (assuming the share price does rise to £20 and the capital gains tax allowance is used elsewhere):
- •Immediately exercise – You hold 530 shares worth £5,300 having already paid £4,700 of tax. The shares increase in value to £10,600 and you sell. Your final position after tax is £10,600 less £1,060 of capital gains tax = £9,540.
- •Hold the options – You hold 1,000 options worth £10,000. These options increase in value to £20,000. You then exercise the options and immediately sell, meaning you pay 47% income tax and national insurance. Your final after tax position is £10,600. If you leave Phoenix on good terms (i.e. a good leaver – illness, redundancy etc.) and your awards haven’t yet vested, you will be able to keep the options awarded on a pro rata basis. For example, if you leave after one year of the three year period, you will keep 1/3 of the options awarded. You are still subject to the 3 year vesting period, however on vest you will only have 6 months to exercise your options instead of 7 years. If you retire from work, you may be able to keep your awards but this it at the discretion of the Remuneration Committee. If you retire and are able to keep some awards, you may find that you can exercise these at a lower rate of tax if you are able to postpone exercising long enough such that you exercise the shares in a tax year where you have no other income, such that you pay 20% and 40% tax on some of the shares. If you leave for any other reason (e.g. resignation) you will forfeit your entitlements.
You should take the time to think about your LTIP awards, particularly as you approach vesting date. They form a good part of your remuneration and can open up some interesting planning opportunities to lower your tax bill or increase your pension annual allowance in any given tax year.
