What are gilts?
Gilts are UK government bonds, with their name derived from “gilt‑edged security,” a term used because their paper certificates once featured a gilded edge to signify their high quality and reliability.
When you buy a gilt, you are essentially lending money to the UK government in exchange for regular interest payments and the return of your original investment at the end of the term.
How do gilts work?
When the government needs to raise money to finance public spending, it issues gilts through the Debt Management Office, typically at £100 each - known as the par or face value.
Each gilt has a fixed term, such as 5, 10, or 30 years, and pays interest at a set rate. This interest is paid in the form of coupon payments, usually twice a year. At the end of the term, you receive your original investment back along with a final coupon payment.
Gilts are similar to a corporate bond, but instead of lending to a company, you are lending to the government. Because the UK government is considered very reliable, gilts carry less default risk than corporate bonds – which will tend to have a higher coupon to compensate investors for the extra risk. Gilts have a very high credit rating, reflecting the fact that interest and capital repayment is guaranteed by the UK government, which has never failed to make payments on time and in full.
What influences gilt prices?
Gilts can be bought from other investors before their maturity date on what is known as the secondary market. Here, the prices of gilts are influenced by several factors, including the level of interest rates, economic conditions, and investor demand.
Shorter-dated gilt yields (reflecting bonds with less than five years to redemptions) are heavily driven by central bank policy, chiefly prevailing Bank of England interest rates, while longer-dated yields mostly reflect future economic health and perceived risks of inflation.
Provided the UK government does not default, an investor will get back the gilt’s par value on the maturity date. However, prices of gilts can vary over time and if you decided to sell the bonds before the maturity date, or needed to sell them due to unforeseen circumstances, you might get back less than you paid for them and realise a loss.
What is a gilt yield?
The gilt yield is the annual return you earn from a gilt, expressed as a percentage of its price. It includes the coupon payments and any gain or loss if you sell before maturity. Yield moves inversely to price. When gilt prices rise, yields fall, and vice versa, and yields change daily as various factors shape what level of yield investors are willing to accept – and therefore the price they are willing to pay.
Are gilts tax free?
The interest you earn from coupon payments on gilts is subject to income tax, but there is no capital gains tax if you sell or redeem a gilt for more than you paid. This can make them attractive for investors who want predictable income without worrying about capital gains tax (CGT). In particular, gilts whose return is mostly capital gain rather than income can be a consideration for those wishing to invest tax efficiently and take a low level of risk.
This has become a more valuable option as the CGT exemption – the amount of capital gains that can be made without being taxed – has been cut from £12,300 to £3,000 over recent years. In practice, this is only an advantage when buying and selling gilts in the secondary market because investors that buy at £100 will redeem at £100 and therefore have no capital gain.
Please note: the tax benefits of holding bonds do not apply if you hold them through a bond fund, such as an ETF.
Can gilts be a good alternative to a savings account?
When an investor buys a gilt, the return is locked in for the term of the bond. With most savings accounts, the bank may change the rate at any time, creating uncertainty. So, in this sense, buying a gilt with a known return and holding until redemption is rather like putting money in a fixed term savings account.
The major difference is that the gilt will produce some combination of tax-free capital return and taxable interest, whereas the savings account will produce only interest. Those who have already exhausted tax efficient options, notably ISAs, as well as allowances such as the personal savings allowance, may look to the CGT exemption of gilts as a way to minimise tax.
This type of investor will tend to look for gilts with low coupons trading below their par value, thereby maximising the tax-free component of return from capital, and which have less than five years until redemption. There are quite a few of these issued during periods when interest rates were much lower.
It is also worth noting that savers are reliant on the creditworthiness of a bank, with the UK government only guaranteeing deposits up to £120,000. With a gilt, the whole amount is backed by the UK government.
How to buy gilts
It is possible to buy gilts directly from the government through the Debt Management Office’s auctions. But far more conveniently, you can purchase them through a stockbroker or investment platform such as Charles Stanley Direct. Our investment managers can also advise on the use of gilts in your portfolio and select the appropriate ones for your needs.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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