Little-known method 'better than savings account after tax'

Little-known method 'better than savings account after tax' A wealth manager said it was often overlooked With income tax rates at their highest for a generation, experts are urging higher-rate taxpayers to look beyond headline interest rates and focus on what they actually keep after tax. According to wealth manager Paul Denley, many investors are overlooking one of the few remaining tax-efficient opportunities available outside an ISA or pension: low-coupon UK government bonds, known as gilts. He said that while most people compared investments based on their advertised return, the tax treatment can make an even bigger difference. Mr Denley, CEO at London-based Oakham Wealth Management, said: “It's not just about what an investment earns. It's about what you keep after tax. “With tax allowances having been reduced over recent years, improving your after-tax return has become much harder. Low coupon gilts remain one of the few notable exceptions.” 'Exempt from tax' Unlike interest earned on a standard savings account, capital gains made on UK government gilts are exempt from Capital Gains Tax. What makes low coupon gilts particularly attractive is that they pay relatively little interest each year, meaning a larger proportion of the overall return comes from the tax-free uplift to their £100 redemption value rather than taxable income. Mr Denley said: “The way low coupon gilts work is surprisingly simple. If you buy a gilt below its £100 redemption value and hold it until maturity, the uplift to £100 is free from Capital Gains Tax. Because the coupon is low, more of your total return comes from that tax-free capital gain rather than taxable interest.” As an example, Mr Denley pointed to a gilt maturing in July 2027 with a gross yield of 4% that currently trades at £97.25. Although the 1.25% annual coupon is taxable, the £2.75 gain when the bond matures at £100 is tax-free. He said: “For a higher-rate taxpayer, that produces an after-tax return of around 3.5%. To achieve the same return from a taxable savings account, you'd need an interest rate of roughly 5.8%. That's simply the tax system working in your favour.” Mr Denley said the strategy was particularly attractive for people holding significant sums outside ISAs or pensions, perhaps following an inheritance, business sale or years of accumulated savings. He also said it was important to choose a gilt that matured when the money is likely to be needed. He said: “Matching the maturity date to your spending plans removes market price uncertainty and allows you to capture the known uplift to par with confidence.” Mr Denley added: “The higher your marginal rate of tax, the more valuable this becomes. A basic-rate taxpayer gains relatively little, but for higher and additional-rate taxpayers the difference can be meaningful.” He stressed that gilts were not without risk. If sold before maturity, their price can fluctuate, while inflation may reduce the real value of returns over time. However, investors who hold an appropriate low-coupon gilt until maturity know exactly what they will receive. “This isn't a loophole or an aggressive tax strategy,” Mr Denley said. “It has always been part of the UK tax system. At a time when taxes are taking a bigger bite out of investment returns than ever before, understanding how your returns are taxed can be just as important as the return itself.”