Low Coupon Gilts and Tax: Why They're So Popular
Ask a higher-rate taxpayer where they park spare cash outside an ISA, and a surprising number will mention gilts. Not just any gilts, though. They tend to want the ones with tiny coupons trading well below £100. There is a tax reason for that, and once you see it, the appeal is hard to unsee.
This article explains the rule that drives it all, shows you how it plays out in the live data, and flags the catches.
The rule that makes gilts special
Gilts have an unusual tax status. For individuals, any capital gain on a gilt is exempt from Capital Gains Tax (CGT). You buy below face value, hold to maturity, get repaid at £100, and the profit is yours with no CGT to pay.
What is not exempt is the coupon. The coupon is the fixed interest a gilt pays, quoted as a percentage of the £100 face value. That interest counts as income. If you hold gilts in a normal dealing account, the coupon is taxed at your income tax rate. For a higher-rate taxpayer that is 40%, and for an additional-rate taxpayer 45%.
So you have two pots of return. One pot, the price gain, is tax-free. The other pot, the coupon, is taxed. The trick is to shift as much of your total return as possible into the tax-free pot.
Why low coupons and low prices go together
A gilt with a small coupon has to make up the difference somewhere. When market yields are around 4% to 5%, a bond paying only a fraction of a percent in coupon can only compete by being cheap. So its price sits well below £100. The gap between what you pay and the £100 you get back at maturity becomes the bulk of your return.
Look at UK Treasury 0.25% 2031. It trades at 80.74 with a yield to maturity of 4.61%. The coupon is a mere 0.25%, so the taxable income is tiny. Almost all of the return comes from the price climbing towards £100 by maturity, and that part escapes CGT.
Compare that with UK Treasury 4.75% 2030. It changes hands near 100.06 with a yield to maturity of 4.73%. The maturities are close, and the pre-tax yields are broadly similar. The difference is where the return sits. Nearly all of the 4.75% gilt's return arrives as coupon, and coupon is taxed. There is almost no price gain to shelter.
For someone paying 40% tax, those two gilts are worlds apart after tax, even though the headline yields look alike.
Examples from the live data
Several low-coupon gilts show the same pattern right now. Prices and coupons are from the current data.
- UK Treasury 0.5% 2029 at 90.88, coupon 0.5%, yield to maturity 4.39%
- UK Treasury 0.375% 2030 at 84.06, coupon 0.375%, yield to maturity 4.8%
- UK Treasury 1% 2032 at 82.01, coupon 1%, yield to maturity 4.76%
- UK Treasury 0.625% 2035 at 68.30, coupon 0.625%, yield to maturity 5.05%
In each case the coupon is small, so the taxable slice of the return is small. The rest is a pull towards £100, tax-free. The 2035 gilt is the clearest illustration. Buy near 68.30, hold to redemption at 100, and the bulk of that 5.05% yearly return is a capital gain the taxman leaves alone.
Who actually benefits
The higher your income tax rate, the bigger the prize. A 45% taxpayer keeps far more of a low-coupon gilt's return than they would from a savings account or a high-coupon bond of the same yield. A basic-rate taxpayer still gains, but the edge is smaller.
The structure matters too. Inside an ISA or a SIPP, gilt income is already sheltered, so the low-coupon advantage largely disappears. These bonds earn their keep in taxable accounts, where every pound of coupon would otherwise be taxed.
The personal savings allowance also plays a part. Higher-rate taxpayers get £500 of tax-free savings interest a year, additional-rate taxpayers get nothing. Low coupons help you stay inside or near that allowance.
The catches to keep in mind
Tax efficiency is not the same as a guaranteed win. A few things to weigh up.
- Price can fall. Gilt prices move as interest rates move. If you sell before maturity, you might get less than you paid. The CGT exemption also means you cannot claim a loss against other gains.
- Lower income now. A small coupon means less cash landing in your account each year. If you rely on regular income, that matters.
- You must hold to maturity to lock in the plan. The tax-free gain is realised when the gilt redeems at £100. Trade in and out, and you are just taking price risk.
- Tax rules can change. The gilt CGT exemption is long-standing, but no rule is permanent. Base decisions on your own circumstances, and take advice if the sums are large.
Low-coupon, sub-par gilts are not exotic. They are ordinary government bonds being used cleverly. For a higher-rate taxpayer holding outside a wrapper, the combination of a modest taxable coupon and a tax-free capital gain can quietly beat alternatives with the same headline yield.
This article is for general information and is not personal financial or tax advice. Bond prices and yields change, past performance does not predict future returns, and your own tax position depends on your circumstances. Consider speaking to a qualified adviser before investing.
Important disclaimer
This article is for information only and is not financial advice. Gilt prices and yields move daily and your capital is at risk. Always do your own research or speak to a regulated financial adviser before investing.
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