UK Index Linked Bonds

TheGreenFrog

"the nominal bond with equivalent coupon will be more tax efficient"... I should add that this applies only to the low coupon nominal gilts which currently have most of the redemption yield factored into the (tax free) discount to par value.  New issues are different (but I don't think there has been a new issue of linkers since 2021).

OldScientist

TheGreenFrog said:

GeoffTF said:

TheGreenFrog said:

If objective is matching inflation then I suppose relevant to this is whether OP's investment is in a tax free or taxed account (and if taxed what OP's marginal tax rate is).  If taxed, inflation will not be matched on a net basis and certain non-linked gilts are worth considering as an alternative.

If you hold gilts directly, they are exempt from Capital Gains Tax. Some gilts, including index linked gilts, have coupons of 0.125%, so there is not much income tax to pay either.

Agree.  But for various reasons the nominal bond with equivalent coupon will be more tax efficient than the linker (just a factor, rather than a reason, to prefer the nominal).  For that and for other reasons (e.g. liquidity/pricing) I would have to have real conviction to go for the linker over the nominal.

Could you explain why the coupon would be more efficient for the nominal than the linker (my only thought is that the nominal coupon is fixed, while the linker coupon will, with high inflation, steadily get larger and hence may trigger more tax).

If holding them to maturity, the choice is likely to dictated by the nature of the liabilities, i.e. inflation linked or nominal. For example, for providing constant inflation linked income, a ladder of linkers would do a better job than one consisting of nominal gilts.

Probably getting away from the OP!

GeoffTF

OldScientist said:

sgog said:

GeoffTF said:

TheGreenFrog said:

If objective is matching inflation then I suppose relevant to this is whether OP's investment is in a tax free or taxed account (and if taxed what OP's marginal tax rate is).  If taxed, inflation will not be matched on a net basis and certain non-linked gilts are worth considering as an alternative.

If you hold gilts directly, they are exempt from Capital Gains Tax. Some gilts, including index linked gilts, have coupons of 0.125%, so there is not much income tax to pay either.

What is a good (low-cost) way of buying linkers directly?

iweb allow this (at £5 per transaction, but there is a bid-ask spread too), but only over the telephone (not online). From memory, it took about 10 minutes or so per bond (I am pleased to note that the person at the other end took great care in ensuring accuracy). Generally the number of transactions with each bond is so small that I took some small pleasure in seeing mine sit on the LSE page for the whole day (sad, isn't it!).

Quite a few other brokers also allow purchase of individual bonds (although Vanguard don't and I don't think Fidelity do either).

The daily volume for most gilts is huge, but most of it takes place on the wholesale market where the spreads are very narrow. The London Stock Exchange has much lower volumes and wider spreads. I have been told that you get better prices for larger trades (>£50K say) with new style index linked gilts (where the trader has to telephone a market maker rather than place the trade online).

GeoffTF

TheGreenFrog said:

"the nominal bond with equivalent coupon will be more tax efficient"... I should add that this applies only to the low coupon nominal gilts which currently have most of the redemption yield factored into the (tax free) discount to par value.  New issues are different (but I don't think there has been a new issue of linkers since 2021).

New issues are auctioned. The price can be at a discount or a premium to par, depending on market conditions. The DMO issues sufficient linkers to satisfy the needs of the pensions industry. There are a few short dated 0.125% conventional gilts, but many more 0.125% long and short dated index linked gilts. The low coupon issues tend to have smaller redemption yields, because of the demand from higher rate tax payers.

TheGreenFrog

OldScientist said:

Could you explain why the coupon would be more efficient for the nominal than the linker (my only thought is that the nominal coupon is fixed, while the linker coupon will, with high inflation, steadily get larger and hence may trigger more tax).

Yes that is what I was referring to.  A small advantage admittedly!

OldScientist said:

If holding them to maturity, the choice is likely to dictated by the nature of the liabilities, i.e. inflation linked or nominal. For example, for providing constant inflation linked income, a ladder of linkers would do a better job than one consisting of nominal gilts.

Agree.

GeoffTF

With regard to tax efficiency, consider two simple examples:

(1). Suppose that a conventional gilt has coupon of 0.1%, sells at 50 and matures at 100. If you invest £100K, you pay tax on £200 every year.

(2). Suppose that an index linked gilt sells at a clean price of 100 and the dirty price is also 100 (i.e. a new issue with no indexation). Initially, you pay tax on £100, but that payment will grow with inflation.

(a). If there is no inflation, the payment from the index linked gilt will not grow..

(b). If there is hyper inflation, the payment will grow massively in nominal terms (but again not in real terms). You will be paying much less tax with the conventional gilt, but your maturity value will be negligible in real terms.

(c). If the clean price of the index linked gilt remains at 100, but the dirty price goes to 200 (i.e. the cost of living doubles), you will be paying tax on £200 in nominal terms, i.e. your tax will have exactly caught up with that for the conventional gilt, and the payout on maturity will be almost the same.

(d). In practice there is usually already some indexation when you buy index linked gilts. Currently, that is typically about or less than 50%.

You need to work ut the tax before you buy. You will find the numbers that you need by setting up a free account here:

https://reports.tradeweb.com/account/login/