Bonds

Bonds are a kind of loan that governments or companies use to raise money, so they are a financial means of corporate lending. They’re essentially a corporate I-O-U, but on a more formal and contracted basis. If you buy a bond, you are technically lending money to whoever issued you with the bond and they are obliged to repay you interest, or the value of the bond at a later date.

There can be some confusing terminology around bonds, so we’ve broken it all down for you:

• The coupon – Interest accrued on a bond
• The principle – The initial loan amount
• The maturity – The eventual value of the bond once it has accrued interest
• Maturity date – The date by which the principle must be repaid in full, or is considered defaulted (unpaid)
• Gilt – A government bond

There are important tax implications of bond profits that you need to be aware of:

• If you earned a coupon (interest) from a bond, that income is taxed as income from savings interest
• If you sell a gilt for a profit, that profit is tax-exempt
• Earnings from bonds held in an ISA are also tax-exempt

Tax efficiency through bonds

When you have a bond in the UK, you may be charged Income Tax when you withdraw from it. But any profits that you make within an investment bond are taxed at 20% and paid out of the bond directly.

There is also a withdrawal allowance of up to 5% each year, which you’re allowed to carry forward if you don’t use it. You can do this without being liable to pay any extra tax.

This means that as a higher rate or additional rate taxpayer (paying 40% or 45% Income Tax), bonds can be a good investment to minimise your Income Tax bill. However, you will be charged the outstanding tax bill on when the bond matures.