Gilts can be an attractive option for investors because they are issued by the government and backed by the Treasury, meaning they hold next to no default risk.
They also have a special tax status: while their coupon (the interest payment you receive) is taxed as income, the capital gains are tax-free. So, low-coupon, high-yield gilts may be a good option for investors who have maxed out their Isa allowance.
Here, Which? explains how gilts work, which bonds are proving popular and how to invest.
Please note the content contained in this article is for information purposes only and does not constitute financial or investment advice.What are government bonds?
Bonds are issued by governments to raise money to finance projects or day-to-day operations. Bonds issued by the UK government are known as gilts.
If you buy a gilt, the government will pay you a regular income in the form of interest payments (known as coupons) for a set period.
When the loan period ends (referred to as the bond maturing), the government must repay your loan.
The total yield, or ‘redemption yield’, is the return investors can expect to make on their investment. It combines the coupon payments you’ll receive and the profit/loss you’ll get if you hold the bond to maturity.
Once launched, government bonds can be bought and sold on the open market (before they mature) where their price can vary quite a bit from the initial launch price.
Find out more:Why are bonds so popular right now?
Having spent years relegated to the investment wilderness, bonds are currently enjoying something of a renaissance.
That’s because the price of existing bonds tends to fall as interest rates rise, which in turn boosts their yield. So, the Bank of England’s repeated rate hikes from record lows up to 5.25% have breathed new life into the bond market.
As an example, three years ago, a gilt maturing in 10 years yielded 0.8% – but today, that return is 4%. Investors are drawn to these higher yields, which have risen due to the falling bond price.
One government bond in particular has proven very popular with investors – the amount held in the UK TN25 gilt, which has an annualised yield of 4.6%, has risen 28-fold since the first quarter of 2023.
Considering the bond’s maturity date (31 January 2025), a £10,000 investment made around now would see a return of approximately £10,373, or 3.7%, on the date it matures.
For comparison, the best one-year fixed Isa currently pays 4.8%, and the best one-year fixed savings account pays 5.18%, according to Moneyfacts.
‘Even inside an Isa or a SIPP, getting around more than 4% annualised from a safe source like the UK government is appealing for many investors,’ said Sam Benstead, fixed income specialist at Interactive Investor.
‘It suggests that investors are treating gilts like short-term savings accounts – picking the maturity date of a gilt that coincides with when they want to get their cash back. They then have plenty of other low-coupon bonds maturing soon that they can reinvest their cash into.’
Find out more:What are the tax benefits?
Each year, you get a £20,000 allowance to invest in an Isa tax-free. But if you've used up your allowance, you might be interested in other tax-efficient ways to save.
The income you get from a bond's coupon payments counts as taxable income. However, you can still use your personal savings allowance (£1,000 for basic rate taxpayers, £500 for higher rate taxpayers) against these interest payments.
But any capital uplift you make from buying and selling government gilts or holding them to maturity will be free from capital gains tax.
Capital gains tax is normally paid on the profit you make when you sell an asset that’s increased in value. Any gains made over your annual exemption amount (£3,000) are usually taxed at 10% for basic-rate taxpayers or 20% for higher-rate taxpayers.
Corporate bonds held outside of an Isa are subject to capital gains tax, but UK government gilts are specifically exempt. This makes gilts with low coupon payments and a high yield attractive for investors since it minimises potential income tax while maximising tax-free capital gain.
A large portion of the total yield from gilts, which were issued when interest rates were near zero, comes from the capital uplift when the bonds mature, making them a useful tool to pay less tax on investments held outside of an Isa.
Find out more:How can you purchase government bonds?
There are a few different options for anyone seeking to buy government bonds.
For example, you can buy gilts directly from the UK government's Debt Management Office.
However, most gilts, government bonds and corporate bonds are traded on the open market, where their price can fluctuate.
The easiest way to buy existing gilts and corporate bonds is either through a stockbroker or via an investment platform.
It’s also important to highlight that corporate bonds are much riskier than government bonds. Investors should always do their own research and make sure they understand how bonds work before investing.
Find out more: undefinedsource https://www.which.co.uk/news/article/maxed-out-your-isa-gilts-are-proving-a-popular-option-for-investors-aWMlL9N54mQl