When making near term investments, cash is often the obvious choice, however there’s something else worth considering just now. For UK higher and additional rate taxpayers, low-coupon gilts (UK government bonds) continue to offer great value for fixed-term low risk savings, when compared to bank accounts. If you are holding significant amounts of cash, for whatever reason, e.g. a known expenditure sometime in the next few years, concern over stock market valuations or simply that you are a cautious type of investor, then these gilts are definitely worth exploring.
Cash is not king, low-coupon gilts are
Most of the return from low-coupon gilts comes from a capital gain – current prices are below the amount you will receive at redemption, and such capital gains are tax-free (yes, you read that correctly – it’s a special feature of UK gilts). Compare this to a fixed-term bank account where all* of the return (in the form of interest payments) is taxed at either 20%, 40% or 45%, depending on which tax band you fall into.
The table below shows 5 such gilts which will mature over the next 6 years. They offer a guaranteed return only if held to maturity (the after-tax returns are shown in the “net return” columns). I have calculated the equivalent interest rate a bank would need to offer for higher and additional rate taxpayers to achieve the same net return. The best fixed rate returns from banks are currently ranging from 4.3% – 4.5% p.a. depending on term so the 5.4 – 7.1% p.a. effective gross return available on these gilts offers great value if you are in the higher and additional rate tax brackets.
In addition, all gilt investments are guaranteed by the UK government, as opposed to only £85,000 for each bank under the Financial Services Compensation Scheme.
All returns in the table above are approximate and based on closing prices on 16 September.
*I am ignoring the relatively small tax-free savings allowance available to basic rate and higher rate taxpayers to keep things simple.