How to buy gilts to beat the taxman on your savings

• 7m savers expected to hand over £6.6bn in tax on earnings made on savings
• Some savers caught in a tax trap by saving in high interest fixed rate accounts 
• Investing in gilts can have an enormous tax advantage  

As the Government readies itself for a record tax haul on savings, clued-up investors have found a clever trick to shield their earnings from the taxman.

Seven million savers are expected to hand over an all-time high of £6.6 billion in tax on earnings they have made on their savings this year, the tax office estimates.

High interest rates on fixed savings accounts should be a boon for households but many are finding themselves caught in a tax trap and will face a hefty bill on the interest they make for the first time in years. 

Luckily, there’s a safe way to earn returns on your money without the taxman taking a slice.

Instead of piling into one-year bonds offered by banks, investing in British Government bonds – known as gilts – can have enormous tax advantages.

Bella Caridade-Ferreira, the investment expert behind comparison website Compare & Invest, says investing in these bonds is a ‘no brainer’ this year. 

They will be especially useful for higher-rate taxpayers who have maxed out their £20,000 Isa allowance and £500 personal savings allowances this year.

Many investors have already wised up to the loophole. Half of the ten most popular investments in September at stockbroker AJ Bell were Government bonds. 

Meanwhile, at stockbroker Hargreaves Lansdown, conventional gilt purchases have increased by 538 per cent over the past 12 months.

Those who make the most of the little-known trick can bag returns above 5 per cent post tax. But to truly take advantage, you’ll need to pick the right gilts and hold them until the end of their term.

WHAT ARE THE BENEFITS OF BUYING INTO GILTS?

Savers who have diligently built even modest nest eggs are now getting stung. This is because interest earned on savings is treated as income and taxed at your marginal rate of income tax.

For basic-rate taxpayers, the taxman takes 20 per cent on interest earned above £1,000 a year, for higher-rate it’s 40 per cent above £500 and additional rate pay 45 per cent on everything they earn. 

These allowances look increasingly miserly as interest rates shoot up.

Investing in gilts has two big benefits. 

The first is that Government bonds are safe investments unlike some other types of bonds – namely issued by countries on the verge of bankruptcy. The second is that the returns you make on them are free from capital gains tax which applies to many other investments, such as shares, funds or investment trusts outside of an Isa.

Gilts are simply IOUs that you can buy off the Government. That money can be used to pay for anything from the NHS to Britain’s schools. In return for lending your cash to the Government, you receive a regular payment known as a ‘coupon’. At the end of the bond’s term, when it matures, you get back the original amount you paid for the bond – known as its ‘face value’. 

The only reason you might not get your money back is if the Government goes bankrupt and is unable to pay its debts. This means that investing in gilts – UK Government bonds – is as safe as putting your money into National Savings & Investments (NS&I) accounts, which are also guaranteed by the UK Government, says Laith Khalaf, head of investment analysis at investment platform AJ Bell.

While the interest you earn from gilts is subject to taxation like any other income, any capital gain you make from them is not.

And because gilts are often traded on the secondary market – for example with stockbrokers – at a discount, you can buy them for below the price you will get back when the gilt matures. This means you can make a guaranteed capital gain at the end of the term.

Jason Hollands, of wealth manager Bestinvest, says that this makes investing in gilts more tax efficient than holding money in cash, particularly for those who have exhausted their Isa allowance and are holding money outside their pensions.

HOW TO UNLOCK RETURNS OF 5 PER CENT-PLUS

The key to success, Khalaf says, is being able to work out how much money you will save in not paying capital gains tax versus how much tax you will have to pay on interest you earn. Once you have mastered this, it is possible to achieve an after-tax yield of over 5 per cent.

His calculations show that a basic-rate taxpayer who has already exhausted his or her personal savings allowance of £1,000 a year could receive a post-tax return of 5.31 per cent on gilts maturing at the end of January 2024.

Higher-rate taxpayers, who only have a £500 savings allowance, will find their return is 5.24 per cent, and additional rate taxpayers 5.25 per cent. 

In contrast, the best-buy, one-year bond from Metro Bank, which pays 5.8 per cent, would give basic-rate taxpayers a post-tax return of 4.68 per cent, higher rate taxpayers 3.51 per cent and additional rate taxpayers 3.22 per cent.

> Check out the best fixed rate deals in our savings table

WHAT ARE THE BEST GILTS TO BUY – AND WHY?

Every gilt will have a different price, coupon and maturity date, which means that you will have to pick carefully.

Fortunately, the maturity date and the coupon are in the name of the gilt, so it is easy to find out this information.

Some examples of gilts with low yields and relatively imminent maturity dates are: Treasury 0.25% 31/01/2025 or Treasury 0.125% 31/01/2028.

To work out the post-tax return you will get, you also need to know the current price of the gilt. For example, the gilt maturing on January 31, 2025 is currently available at £95.15. This will return £100 at the end of the term.

That means you would receive a capital gain of £4.87 for every £95.15 you spent on this gilt now, or 5.1 per cent of your investment. You would also receive a yield of 0.26 per cent, or 26p for every £100 you invest – on which you would have to pay tax.

According to AJ Bell, the average gilt buyer purchased £129,000 worth of gilts in September.

If you want to tuck your money away for longer, the sums look slightly different. The gilt maturing on January 31, 2028, is currently available at a price of £85.31.

On January 31, 2028, it will return you £100, so you will receive a capital gain of 17 per cent of your original investment over a period of just over three years. You will also receive a taxable coupon payment.

DAUNTED? HERE’S HOW – AND WHERE – TO BUY

If you have never bought gilts before, the process can seem daunting. You will need to account for the charges for both buying and holding the gilts.

You can buy Government bonds directly through the Debt Management Office, which is the Government’s debt issuer.

It offers a gilt purchase and sale service, meaning that you can buy and sell gilts that are already in the market.

To use it you must become a member of an ‘approved group’ of investors, and you will be charged 0.7 per cent of the value of the gilts to buy them and the same to sell them, with some reductions if you are dealing with more than £10,000 of gilts at a time.

There is more information about this service at dmo.gov.uk.

Alternatively, you can buy and sell gilts through a stockbroker or online trading platform. Many of them only allow you to buy gilts over the phone although some have a select number that can be bought online.

MAKE SURE YOU USE UP YOUR ALLOWANCES FIRST

While gilts can offer significant tax advantages, not everyone should use this loophole.

Make sure you first use up all your personal savings allowance. If you don’t pay tax on your savings interest, it may be cheaper to use a high interest savings account.

The same goes if you still have some of your £20,000 Isa allowance to use up. Virgin Money has a one-year Isa at 5.65 per cent.

If you are saving for retirement you may be better off using a pension – the tax relief benefits are too great to miss.

And if the calculations on gilts are too complex, don’t take the risk. Use savings instead.