Tax-efficient savings: Premium bonds vs gilts

jifmoose

I am conscious this is a bit of an apples-and-oranges question and probably involves some incommensurable value calls, but would still be interested in views - and to see if there's anything I'm missing here.

So I'm a higher rate taxpayer, and will certainly blow through the £500 PSA for savings this year. I've maxed out my ISA this year - I have some savings in easy access accounts/regular savers and have put as much as I'm comfortable risk-wise into a Stocks GIA. Already put a lot into the mortgage and happy with pensions.

That leaves about 5K that "I don't know what to do with". Any saver rate, once I factor in the 40% tax on interest, struggles to effective beat 3%. Now conventional knowledge seems to be premium bonds are pretty lackluster with returns (with average luck). They were right at the bottom of my list, but the tax-free nature of returns - combined with their extreme simplicity and safety - has made them attractive to me. I think the MSE calculator is showing 3.25% effective "interest" rate with average luck.

So the 5K is in premium bonds for now (in time for the Sept draw, at least).

Now, premium bonds are sort of fun, but also seem a bit, well, lame. I am intrigued by the possibility of using UK gilts for an equivalently safe investment, holding them to maturity for an tax efficient return. The trouble is, I know almost nothing about them.

So what are people's views on a relative newbie getting involved with gilts? Is it a pain/are there pitfalls getting set up with the platform? Is the added complexity worthwhile? What sort of investment and timeframe is appropriate (would 5K over a year e.g. be far too little or too short?). Any gotchas to be aware of? I know that zero coupon "strip" gilts aren't tax exempt. I almost certainly will not meet the £3K CGT threshold (unless my GIA stocks do very well).

On the other side, am I right to think of Premium bonds in this way? Is safe, fun but not very profitable a good way to think of them?

masonic

For small sums like £5k, and even for large sums over short holding periods, the chance of winning nothing or next to nothing is appreciable, so premium bonds wouldn't make much sense even for a higher rate taxpayer.

With gilts, you have to consider the costs and the time you will need to invest to understand them. There will be a trading fee to purchase each gilt, so this will eat into returns for smaller sums over short holding periods. It would probably not make sense to invest in a gilt with a maturity of less than a year, despite there currently being 4 of these to choose from. Beyond that you would be looking for those with a low coupon as the interest is taxable, but the capital gain is not. You have TN28 with a maturity in about 2 and a half years and a low coupon of 0.125%, where yield to maturity is 3.7% and very little of that would be taxed. Gilts with a low coupon are an artefact of previously ultra-low rates, and pickings are quite slim when you go much beyond that. Whereas low coupon index linked gilts with very long maturities are available. But index linking adds another layer of complexity, so I'd suggest learning to walk before you run. With conventional gilts, you need to understand concepts like accrued interest and the relationship between coupon, price, running yield and yield to maturity.

For a sum like £5k, if you have not already exhausted all of the regular savings options at 6-7%, then it probably isn't worth it. Even drip-feeding a £5k lump sum into a couple of these from a promotional 5% easy access account would give a similar overall return with a lower level of complexity.

Eyeful

May be this will help you understand gilts better:
https://www.youtube.com/@Pensioncraft/search?query=gilts

Albermarle

For a higher rate taxpayer that has used all their ISA allowance and wants to save more money, PBs are as good a place as any.
As mentioned the issue can be that the more you have and the longer you keep them, then the more likely you will achieve something around the expected prize rate/return.
For smaller amounts held for shorter periods, you might get a very good return if you hit lucky and you might well have a few months and get very little/nothing.

OldScientist

How quickly do you potentially need access to the £5k (e.g., instant access, locked away for a year, locked away for 5 years)?

Easy access: Will give you after tax rates of approximately 0.6*4.5=2.7% (variable)
Fixed rate accounts will be similar (but fixed)

Gilts are trickier since in a GIA, the capital gains are tax free while the coupons are taxed the same as interest. So, people in your situation often look for low coupon gilts. For example,

T26 (1/8 coupon, matures in January 2026) is currently dirty priced (i.e., including accrued interest) at 98.689, so, if my calculations are correct, £5k would in January would give you £5066 tax free and about £6 of interest (only part of which will be taxable). An AER of about 3.3% (see https://giltsyield.com/bond/ for yields on all available gilts).

TN28 (1/8 coupon, matures January 2028) has a yield of about 3.7%. The annual return will be about the same provided the gilt is held to maturity

If you're happy to tie this money up for even longer, then there are a few other low coupon gilts that can be found maturing much later (see earlier link). However, if you are forced to sell before maturity then the price will depend on maturity and yields when you sell (if yields go up, prices go down and vice versa) and you could lose (or gain) money.

Fees will depend on the platform. For example, at iweb, currently there is a transaction charge of £5 for purchase, but no holding fee. So you'd lose roughly 5/5000=0.1% off your return. I've not held gilts at other platforms, so others will have to chip in with the likely costs.

jifmoose

Thanks everyone for the detailed and thoughtful replies! In particular, thanks for the examples and calculations with specific gilts (with platform fees) - that's extremely useful.

Yeah my expectations for the PBs aren't too high. Any month I actually win £25 is a good one. But as mentioned the problem is returns will be very lumpy in the short term.

I don't have any pressing need for the 5K - could easily lock it away for a year. 5 years I might want to get my paws on it. I do really like the regular savers (currently got 6!). In an emergency I can always raid those or my flexible ISA.

Newbie_John

I've had spare £5k and was planning to use it to make my home greener but instead invested in Greencoat UK Wind, decent dividends as well 9% now.

If you're not into that there's plenty more with decent dividends payouts - and you get £500 a year tax free.
You also get £3000 CGT free, if you have no space in ISA