Gilts for additional rate income

[Abtj]

Hi,
Following some other live thread discussions can someone please explain Gilts and confirm or correct my thoughts.

As an additional tax payer looking at gilts, should I be looking at a maturity price below 100 and low coupon value (<0.5%). My aim is that I don’t want to ‘earn’ any more interest at additional rate, I’d prefer to receive the mature payment without suffering CGT - is that right?

ISA is full already and I’m looking at other options to S&S’s.

As someone else has been asking about property- I would also run a mile from BTL/development even on lower income, beyond a certain income it seems crazy to me to even consider.

And if you’re thinking the obvious, I really do want to try to avoid further fees with IFAs - the rates I’ve been offered are to my eyes unnecessarily high.

Thanks

[Lardydah]

Abtj said:

As an additional tax payer looking at gilts, should I be looking at a maturity price below 100 and low coupon value (<0.5%). My aim is that I don t want to earn any more interest at additional rate, I d prefer to receive the mature payment without suffering CGT - is that right?

Yes that's my understanding, for example the Treasury 0.125% 31/01/2028 (TN28) can be bought at ~91.67 and will be redeemed at 100 at the beginning of 2028 - the difference between the purchase price and redemption would be profit which would not attract any tax. You'd still receive the 0.125% coupon payment which would count as income and be taxed as such, but it's minimal.

Not an endorsement of HL just an easy site to get the info from.

Remember you're taking interest rate risk (similar to if you were to enter into a fixed rate savings account - you are locked in if rates go up - you can always sell a gilt but if rates rise you may take a loss - not a problem if you plan to hold to maturity and are happy with the initial rate) and credit risk (although v unlikely UK would default on a gilt).

[deggles]

What he said

Yieldgimp.com has a good table showing you the equivalent yield based on your marginal tax rate. You can get the equivalent annual return of >6% if you're an additional rate taxpayer.

[Abtj]

Thanks both.

So when looking further out - such as TG35 at 68.36 - if held to maturity do you get paid out at 100?

The grossed up equiv yield is 7.74%

[NowWatchThisDrive]

Abtj said:

Thanks both.

So when looking further out - such as TG35 at 68.36 - if held to maturity do you get paid out at 100?

The grossed up equiv yield is 7.74%

Yeah, although a) obviously that's nominal not indexed to inflation, and b) the further out you go the more interest rate risk you're running in the event that you do have to sell before maturity.

[LeoSayer]

You haven't mentioned pensions or a spouse which could help to mitigate tax if you have them.

[Abtj]

NowWatchThisDrive said:

Yeah, although a) obviously that's nominal not indexed to inflation, and b) the further out you go the more interest rate risk you're running in the event that you do have to sell before maturity.

Thanks. Is the main risk that I need to withdraw before maturity?

I’ve come to the conclusion (no doubt wrong but works for my brain) that I’d like a few pots that I know I can’t touch until x but by that time they’re worth y. Then I don’t mind keeping some funds in shares that can fluctuate but hopefully gain over time.

Any advice I’ve been given always seems to protect what I have so I’d like to know I’m running some of my funds down over time and can’t work out a better way to achieve this

[Abtj]

LeoSayer said:

You haven't mentioned pensions or a spouse which could help to mitigate tax if you have them.

Thanks - I don’t think there’s much scope there in the short term. My issue is incurred interest. Any answer to that is welcome

[isleofthorns]

am long the 61 gilts at 25p.

beginning to think these may not pay out.... my advice, don't go too far out -

[NowWatchThisDrive]

isleofthorns said:

am long the 61 gilts at 25p.

beginning to think these may not pay out.... my advice, don't go too far out -

Ah, the widowmaker of the gilt curve Not for me but I've heard quite a few have backed up the truck on these, obviously not aiming to hold to maturity but instead benefit from the uber duration + convexity if (when?) the long end reprices big time. The longer you have to wait the less attractive the IRR is, though - and while you'd hope never to be sitting on a MTM loss from here, I'm sure the people buying them in 2022 said the same thing

Abtj said:

Thanks. Is the main risk that I need to withdraw before maturity?

Yep, as you'd then be at the mercy of market movements since your purchase, as opposed to the principal repayment you'd have locked in by holding to maturity. As I said, inflation is the other thing the further out you go, which you can sort of mitigate with index-linked gilts (a.k.a. linkers). But they're a bit more complex than nominal gilts, and I say "sort of" because in practice they're not quite as straightforward as being a perfect inflation hedge.

[Abtj]

isleofthorns said:

am long the 61 gilts at 25p.

beginning to think these may not pay out.... my advice, don't go too far out -

Is that because you’re worried they will default?

[isleofthorns]

Abtj said:

isleofthorns said:

am long the 61 gilts at 25p.

beginning to think these may not pay out.... my advice, don't go too far out -

Is that because you re worried they will default?

there's always the risk of default, even by a sovereign issuer. i think the risks of this are def higher than they were, even if that is still low.

5% yield just seems too cheap for exposure of that timeframe to an economy with so many issues.

I've been trading these for a few years - buying the dips and selling the rallies. Been fairly confident buying in the past at these levels but am not so sure ATM. Think yields could go further in the near term.

if you're buying to take advantage of the tax-free CGT uplift, I'd buy to match when you needs the funds back.

Buying at the long end is way more speculative.

[mark seeker]

isleofthorns said:

am long the 61 gilts at 25p.

beginning to think these may not pay out.... my advice, don't go too far out -

I tend to agree here, don't go too far out in the case you're not holding to maturity (which is unlikely in this case), it wasn't that long ago that TG61 was 32p...

[bitchstewie]

Absolute rule of thumb (I don't work in finance so treat this with the contempt it deserves).

Capital gain i.e. you buy at 95 and you wait until full maturity at 100 is CGT free.

Coupon (interest payments) are subject to tax but that depends on your personal situation.

So the tax situation may drive whether you look at low yield or higher yield.

The duration (when the gilt matures) very broadly means the gilt will probably be more sensitive to interest rate changes.

Bit of a balancing act basically and if you look at what some long dated gilts did when interest rates very quickly changed by a lot you'd probably st yourself - lots of people did.

"Safety" as in you are pretty much guaranteed to get all of your money back if you hold a UK government gilt until maturity is not the same thing as volatility - as lots of people found out.

Do your homework basically especially if this is a life changing sum or a sum you may want to cash out at some random point

[Abtj]

bhstewie said:

Absolute rule of thumb

The duration (when the gilt matures) very broadly means the gilt will probably be more sensitive to interest rate changes.

Bit of a balancing act basically and if you look at what some long dated gilts did when interest rates very quickly changed by a lot you'd probably st yourself - lots of people did.

"Safety" as in you are pretty much guaranteed to get all of your money back if you hold a UK government gilt until maturity is not the same thing as volatility - as lots of people found out.

Do your homework basically especially if this is a life changing sum or a sum you may want to cash out at some random point

Thank you, v helpful. A couple of qs as I’m a bit thick:

1 What at do you mean that the duration means the gilt will be more sensitive to interest rate changes? Is that if I decide to sell? If I’m locked in and going to see it at maturity, does it matter?

2 How do long dated gilts change with interest rates? Assume you mean that if interest rates change and go high that I’ve locked in to something that is effectively deflating? If that’s the case I’m not too worried as I’m looking for something that I can achieve 6% on without too much risk (this may be naive) when comparing against long term inflation figures.

Finally, this isn’t a life changing sum, I’d just like to know that one pot is growing at an adequate rate whilst incurring low tax in the short term. I’ve also considered an offshore bond but I’ve not found one I can do myself without an IFA.

[Abtj]

isleofthorns said:

there's always the risk of default, even by a sovereign issuer. i think the risks of this are def higher than they were, even if that is still low.

5% yield just seems too cheap for exposure of that timeframe to an economy with so many issues.

I've been trading these for a few years - buying the dips and selling the rallies. Been fairly confident buying in the past at these levels but am not so sure ATM. Think yields could go further in the near term.

if you're buying to take advantage of the tax-free CGT uplift, I'd buy to match when you needs the funds back.

Buying at the long end is way more speculative.

I’m looking at 10-15 years

[NowWatchThisDrive]

Abtj said:

Thank you, v helpful. A couple of qs as I m a bit thick:

1 What at do you mean that the duration means the gilt will be more sensitive to interest rate changes? Is that if I decide to sell? If I m locked in and going to see it at maturity, does it matter?

2 How do long dated gilts change with interest rates? Assume you mean that if interest rates change and go high that I ve locked in to something that is effectively deflating? If that s the case I m not too worried as I m looking for something that I can achieve 6% on without too much risk (this may be naive) when comparing against long term inflation figures.

Finally, this isn t a life changing sum, I d just like to know that one pot is growing at an adequate rate whilst incurring low tax in the short term. I ve also considered an offshore bond but I ve not found one I can do myself without an IFA.

Duration actually means two things simultaneously:
1 - weighted average time to receive all a bond's future cashflows, a.k.a. "Macaulay duration"
2 - bond's sensitivity to interest rate changes; a.k.a. "modified duration"

Mathematically these are really two sides of the same coin so you can almost use them interchangeably, but when investing literature talks about "duration" it's generally shorthand for the latter, which is a more useful measure in practice - e.g. a duration of 4 tells you that if yields go up/down by 1% then the bond's price goes down/up by 4%.

Strictly speaking, the relationship between yield and price is convex not linear, duration just gives you a linear approximation that's more accurate for small changes (like comparing speed vs acceleration). For longer dated bonds, particularly like the 2061 being mentioned here, this convexity really comes into play and you end up seeing big moves in its price when the long end yields move around. With a (modified) duration of ~27 and convexity of ~9, if (and it's a big if) long end rates rally 1% you'd make about 40% tax-free by my crude maths. This is really what the people buying the 2061s are betting on (and reasonably soon), no one is holding them right through to 2061 to get paid back at par.

[bitchstewie]

Abtj said:

Thank you, v helpful. A couple of qs as I m a bit thick:

1 What at do you mean that the duration means the gilt will be more sensitive to interest rate changes? Is that if I decide to sell? If I m locked in and going to see it at maturity, does it matter?

2 How do long dated gilts change with interest rates? Assume you mean that if interest rates change and go high that I ve locked in to something that is effectively deflating? If that s the case I m not too worried as I m looking for something that I can achieve 6% on without too much risk (this may be naive) when comparing against long term inflation figures.

Finally, this isn t a life changing sum, I d just like to know that one pot is growing at an adequate rate whilst incurring low tax in the short term. I ve also considered an offshore bond but I ve not found one I can do myself without an IFA.

I know it seems to happen but others can explain the financial reasons better than I can - I just know if you buy a gilt with 20 years on it and interest rates change massively you'll likely see the value of that gilt change and possibly by a lot.

Fine if you can ignore the temporary volatility but a lot of people equate gilts with safe - and safe and volatile are different things.

I don't think 6% figure is realistic but I haven't looked at gilts for a while.

[isleofthorns]

NowWatchThisDrive said:

For longer dated bonds, particularly like the 2061 being mentioned here, this convexity really comes into play and you end up seeing big moves in its price when the long end yields move around. With a (modified) duration of ~27 and convexity of ~9, if (and it's a big if) long end rates rally 1% you'd make about 40% tax-free by my crude maths. This is really what the people buying the 2061s are betting on (and reasonably soon), no one is holding them right through to 2061 to get paid back at par.

typically this...

looking for the rebound from 25 to 30 level... can happen pretty quickly on a little bit of good news. Conversely, the risks are also to the downside and 20 level is not out of the range of possibilities.....

one small point,,, as the price keeps going down, the running yield goes up! so, a 0.5% coupon becomes a 2% yield at these prices. Maybe not enough incentive to hold, but every bit helps!

[Jon39]

Abtj said:

Hi,
Following some other live thread discussions can someone please explain Gilts and confirm or correct my thoughts.

As an additional tax payer looking at gilts, should I be looking at a maturity price below 100 and low coupon value (<0.5%). My aim is that I don t want to earn any more interest at additional rate, I d prefer to receive the mature payment without suffering CGT - is that right?

ISA is full already and I m looking at other options to S&S s.

As someone else has been asking about property- I would also run a mile from BTL/development even on lower income, beyond a certain income it seems crazy to me to even consider.

And if you re thinking the obvious, I really do want to try to avoid further fees with IFAs - the rates I ve been offered are to my eyes unnecessarily high.

Holding to maturity will of course lock in the arithmetic for you, but don't ignore the reducing value of money.

An aspect to consider, that seems very rarely to be mentioned, inflation.
The £100 redemption at maturity is of course not the same Pound as at issue.
Fixed interest rate long-term gilts, have a hidden killer, inflation.

Many PH gilt holders, who presumably intended to sell before maturity, were posting distraught messages during 2022.
They seemed completely surprised by the dramatic fall in gilt prices.
Clearly no understanding about the inverse relationship between interest rates and gilt values, or of the long-term average base rate.

Perhaps some gilt buyers during the 10 year period following the Global Financial Crisis might, without realising it, had even thought base rates under 1% were normal. The reality being, they were actually the lowest since 1694. Quite a shock for them during the 12 months between December 2021 and December 2022. Base rates increased from 0.1% to 3.5%, a 35 times increase.
Long-term gilt prices fell dramatically.