How UK Savers Can Benefit from Buying Below-Par Gilts

While savers in the UK are enjoying above 6 per cent on their savings, there is a group of smart investors cashing in on short-term gilts, otherwise known as government bonds, that offer just 0.25 per cent. The Daily Mail breaks down why these seemingly low-yield investments can give better after-tax returns than even the best savings accounts.

Breaking Down the Gilt Rush

A recent uptick in demand for short-term government bonds, or ‘gilts’ as they’re known in the UK, has led to a significant increase in fixed income investments made this year. Trade on the interactive investment platform has seen an astounding 721 per cent increase this year up to September, as compared to the same timeframe the previous year.

These gilts promise investors regular interest payments, called a coupon, over a predefined period in return for lending the UK government their money. At the end of the tenure, gilts also repay investors the initial amount lent. Here’s where the real opportunity arises for investors who purchase them at a cost lower than their par value (the initial amount a gilt was issued at, commonly £100). Such investors could gain profits capital gains tax-free upon resale or at the end of the bond’s tenure, providing a unique opportunity to maximize returns.

Understanding the Attraction of Short-Dated Gilts

With gilts, it’s all about the yield: the interest payment, or coupon, expressed relative to the par value of the investment. For instance, a £100 gilt payment of £5 would have a yield of 5 per cent. So what’s happening currently is savers are buying short-dated gilts at prices lesser than their par value. The movement of the bought price to the par value represents the gilt’s increase, which, crucially, is not subject to capital gains tax (CGT).

In a practical scenario from late September 2023, an investor could buy a gilt below its par value, 94.26 pence in the pound to be exact, with an annual return of just 0.25 per cent and a maturity date of 31 January 2025. While 0.25 per cent might appear a small return, the 5.74p capital appreciation from 94.26p to 100p, which is exempt from CGT, makes this investment a potentially rewarding one.

Tom Becket of Canaccord Genuity sheds light on this, indicating that the returns earned on these investments by some top-tier taxpayers have been comparable to those from taxed savings accounts offering almost 9 per cent interest.

A Shift in the UK Market

Interest rates have seen a significant shift, with the base rate climbing from 0.1 per cent to 5.25 per cent as of late 2023, in response to rising inflation. This recent uptick in interest rates has increased the returns the UK government offers on new gilts, to attract investors. Consequently, there has been a reduction in demand for pre-existing gilts, leading to a drop in their prices.

How to Make the Most of this Opportunity

Investors are advised to seize these opportunities quickly, as the appreciation potential of these bonds will decline as they approach their maturity dates. Additionally, the specter of changing interest rates always looms large. If rates rise but not as significantly as currently anticipated, and proceed to plateau before slowly falling, attractive gilt yields may remain available longer.

Investors with large capital may prefer to directly invest via Canaccord Genuity’s Gilt Portfolio Service. However, entry-level investors can access these gilts through platforms like Hargreaves Lansdown, AJ Bell, Interactive Investor or Killik & Co.

Gilts versus Traditional Savings Accounts

From a tax-efficiency standpoint, gilts potentially offer better returns than traditional savings, especially for those with significant savings. Because of the recent spike in interest rates, many savers are faced with potential taxation on their interest income beyond the exemption limit.

This is where gilts have an advantage. The capital appreciation on their investment is tax-free, and with relatively low coupon rates, only those investing large amounts are likely to pay tax on their interest earnings.

While Gilts present an opportunity to potentially outperform traditional savings accounts right now, it’s essential to note that unlike savings, gilts do carry a level of risk. Therefore, it’s always wise for investors to approach such a decision cautiously or seek professional financial advice, especially if dealing with large amounts.