Bond Watch: capital gains tax rise boosts gilts’ appeal

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.     

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.          

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Gilts have a special tax status

The Budget was a non-event for gilt prices, with yields gently ticking down (a result of rising prices) following Rachel Reeves’ speech.

Gilts maturing in a decade yield around 4.2%, while two-year gilts yield a similar amount.

This followed a period of rising yields ahead of the Budget as investors looked to price in changes to the fiscal rules and rising taxes.

The big news items in the Budget were the inclusion of SIPPs in the estate for inheritance tax purposes, increases to stamp duty on second homes, and changes to employers’ National Insurance contributions.

The chancellor also announced an increase in capital gains tax (CGT), from 10% to 18% for basic-rate income taxpayers and from 20% to 24% for higher and additional rate payers.

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Those earning more than £50,270 (including capital gains) fall into the higher capital gains tax band. There is no CGT on the first £3,000 of gains each tax year.

There is no CGT on gilts, although coupons are taxed as income. This means that gilts are a useful tax-planning tool for those who have maxed out their ISAs or SIPP – and gilts are becoming ever more valuable in this regard due to rising CGT rates and a falling CGT-free allowance.

Gilts deliver returns – backed by the UK government – in two ways. The first is by the coupons, set when the gilt is issued. The second is the return of their £100 principal to the bond holders when they mature. The total return of a gilt is its “yield to maturity”, which accounts for the return of the principal and coupon payments along the way.

Because lots of gilts were issued when interest were close to zero, there are many gilts available to buy today that trade at big discount to their £100 redemption value. The difference between the gilt purchase price and the £100 redemption value is free from CGT.

This has not gone unnoticed by ii customers. The most-popular gilts throughout 2024 mature soon and have low coupons, meaning most of their return is capital gain rather than coupon income. They include UNITED KINGDOM 0.25 31/01/2025 (LSE:TN25), UNITED KINGDOM 0.125 31/01/2028 (LSE:TN28), UNITED KINGDOM 0.125 30/01/2026 (LSE:T26), and UNITED KINGDOM 0.375 22/10/2026 (LSE:T26A).

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Interest in gilts has been rising. Total gilt trades in 2024 (January to September) increased 56% on the same period last year, while the total amount added to gilts so far this year (to end of September) is 65% greater than at the same point last year.

There was an 18% jump in gilts’ share of total trades on the platform in August and September compared with July. Significantly, there was an 30% increase in the value added to gilts from August to September.  

This year saw the introduction of IPOs on gilts at ii, which may have contributed to the increased trading activity in 2024.

But consistently high yields could also have been a factor, with 10-year gilts offering around 4% for most of 2024, and shorter gilts hitting highs of around 4.6% at the start of the year. Fears around rising CGT rates also could have contributed.