With income tax rates at their highest level in a generation, financial experts are urging higher-rate taxpayers to look beyond headline interest rates and focus on what they actually keep after tax. According to wealth manager Paul Denley, many investors are overlooking one of the few remaining tax-efficient options outside an ISA or pension: low-coupon UK government bonds, known as gilts.
How Low-Coupon Gilts Work
Unlike interest from a savings account, capital gains on UK government gilts are exempt from Capital Gains Tax. Low-coupon gilts are particularly attractive because they pay modest interest each year, meaning a larger portion of the total return comes from the tax-free increase to their £100 redemption value rather than taxable income.
Mr Denley, CEO of London-based Oakham Wealth Management, explained: "The way low coupon gilts work is surprisingly simple. If you buy a gilt below its £100 redemption value and hold it until maturity, the uplift to £100 is free from Capital Gains Tax. Because the coupon is low, more of your total return comes from that tax-free capital gain rather than taxable interest."
Real-World Example
To illustrate, Mr Denley highlighted a gilt maturing in July 2027 with a gross yield of 4% that currently trades at £97.25. While the 1.25% annual coupon is subject to tax, the £2.75 gain when the bond reaches maturity at £100 is entirely tax-free.
"For a higher-rate taxpayer, that produces an after-tax return of around 3.5%," he said. "To achieve the same return from a taxable savings account, you'd need an interest rate of roughly 5.8%. That's simply the tax system working in your favour."
Who Should Consider This Strategy
Mr Denley described the approach as particularly appealing for individuals holding substantial sums outside ISAs or pensions, perhaps following an inheritance, business sale, or years of accumulated savings. He stressed the importance of selecting a gilt that matures when the funds are likely to be needed.
"Matching the maturity date to your spending plans removes market price uncertainty and allows you to capture the known uplift to par with confidence," he said.
Risks and Tax Considerations
Mr Denley added: "The higher your marginal rate of tax, the more valuable this becomes. A basic-rate taxpayer gains relatively little, but for higher and additional-rate taxpayers the difference can be meaningful."
However, he cautioned that gilts are not without risks. If sold before maturity, their value can fluctuate, and inflation may erode real returns over time. But investors who hold a suitable low-coupon gilt to maturity know exactly what they will receive.
"This isn't a loophole or an aggressive tax strategy," Mr Denley said. "It has always been part of the UK tax system. At a time when taxes are taking a bigger bite out of investment returns than ever before, understanding how your returns are taxed can be just as important as the return itself."
