The end of the tax year is approaching fast, which means you should start thinking about how to allocate your £20,000 annual individual savings account (Isa) allowance, if you haven't already done so. If you max out the allowance, there is an additional consideration. Those who use the allowance in full also face the complicated task of figuring out which assets to prioritise holding in a tax wrapper, in order to reduce future tax bills as much as possible. This is particularly true at the moment for those looking to invest in bonds directly – although there is a case to be made for investing in other assets when current holdings mature.
The usual caveats apply. First, don’t let tax considerations fundamentally change your investment strategy. Second, use up your Isa allowance and make the most of pension contributions first, because a tax wrapper is the best way to shield your investments from capital gains and dividend tax. After that, you may still have some money to invest in a general investment account, for example if you find yourself with a big lump sum to allocate. You also cannot access the money you hold in a pension until you are age 55 (or 57 as of 2028), so a general investment account might be more convenient in some cases.
Ian Cook, financial planner at Quilter, says that while it depends on your personal tax position, you should generally prioritise holding your highest-growth shares and highest dividend-paying stocks in your Isa. UK government bonds, on the other hand, are quite low priority for tax wrappers.
In the case of bond funds, when held outside of tax wrappers you are exposed to both capital gains tax (CGT) on any gains you make on the purchase price, and to income tax on the interest they pay. But directly held gilts are exempt from CGT. While the income received from such bonds is subject to income tax, those bonds issued at times when yields were very low – for example around the start of the pandemic – will have coupons that pay out amounts too minimal to result in a material tax liability.
This is broadly accurate for gilts at any given time, but at the moment there is also a more specific opportunity in the short-duration corner of the market, Cook says. You can currently buy short-term gilts, that pay small levels of income, at a lower price than their value at maturity. For example, as of 23 January, the Treasury 0.25% 31 January 2025 gilt (a bond maturing in January 2025 paying a 0.25 per cent coupon) could be bought for £95.68. When it matures, this value will be £100. Most of the returns you make in this situation derive from capital gains and as such are tax-free.
This can be particularly helpful if you are a high or additional-rate taxpayer, for whom the personal savings allowance is £500 and zero, respectively. The interest rate you earn on your cash, for example via a standard non-Isa savings account, is taxed quite heavily, so short-term gilts can make for a more tax-efficient alternative.
But while gilts are exempt from CGT, other types of bonds are usually not. Corporate bonds bought directly from the issuer and issued in pounds are also CGT-free as long as they are deemed “qualifying corporate bonds” by HMRC. In practice, however, investors will usually exchange corporate bonds on secondary markets, so CGT will apply.
