Buy Gilts Direct and the Capital Gain Is Tax-Free — Bond Funds Hand You the Same Yield, Minus the Trick

Everything else about direct gilts versus a fund is a rounding error. The fees are tiny either way. The yields are almost identical. Liquidity is adequate in both.

The only structural difference that moves real money is the tax treatment of capital gains, and it only moves in one direction.

Read the HMRC guidance in plain English: "You do not pay Capital Gains Tax on... UK government gilts and Premium Bonds." Full stop. No holding period test. No issuer restriction beyond "UK government". Conventional gilts, index-linked gilts, strips — all in.

Now hold a gilt fund in a taxable account and you get the opposite. The fund's NAV reflects the underlying gilts' prices, but HMRC treats your units as ordinary collective investment scheme shares. Sell above cost, you have a chargeable gain. In 2026/27 that is 18% for basic-rate payers and 24% for higher-rate payers on any gain above the £3,000 annual exempt amount.

Context matters too: the Bank of England holds Bank Rate at 3.75%, the curve is steepening, and the post-tax economics of direct gilts only improve if yields stay elevated longer than the market expects.

The CGT bill on a fund is not always big. But it is never zero when the fund appreciates. On a direct gilt it is always zero. That is the whole argument.

The trick is not to buy any gilt. It is to buy a low-coupon gilt trading below par, so most of your total return arrives as a capital gain rather than a coupon.

Coupons on UK gilts are taxable as savings income. Outside an ISA or SIPP, that is 20%/40%/45% depending on your marginal rate (minus the Personal Savings Allowance of £1,000/£500/£0). So a 5% coupon gilt held in a general investment account hands a higher-rate taxpayer a 40% haircut on every coupon payment.

A low-coupon gilt — a 0.25% coupon issue trading at, say, 80p in the pound — pays almost nothing taxable as income. The investor's return comes almost entirely from the gilt pulling to par at maturity. That pull-to-par is a CGT-exempt capital gain.

For a basic-rate taxpayer the gap narrows. For higher-rate payers who have used their £500 Personal Savings Allowance already, it is the difference between keeping roughly £4.30 per £100 per year and keeping £2.70. That is real money repeated every year you hold.

This is the point most people miss. A UK-domiciled bond fund or ETF does not acquire the tax status of what it holds. The wrapper matters more than the holdings.

When Vanguard's UK Gilt UCITS ETF (VGOV, OCF 0.05%) or iShares Core UK Gilts UCITS ETF (IGLT, TER 0.07%) rises in price, selling your units is a disposal of a UCITS fund. Chargeable. Same rules as selling shares in any other investment trust or ETF.

The distributions are handled as interest and taxed accordingly, which mirrors holding a gilt directly. But the price appreciation — which is usually where the larger part of total return sits when yields are falling — is caught. A fund that doubles over a decade because duration does its work during a rate-cutting cycle will hand you a six-figure CGT exposure if you are selling down from a taxable pot.

ISA-wrapped, none of this matters. SIPP-wrapped, none of this matters. But once you have filled both allowances — £20,000 ISA, £60,000 pension — the next pound of bond exposure belongs in direct gilts, not a fund. For anyone with meaningful taxable savings, that threshold comes fast.

Two obstacles get cited as reasons to stay in a fund: the bid-offer spread on individual gilts, and the admin of managing maturities.

Both are overstated.

Spreads on benchmark gilts at Hargreaves Lansdown, AJ Bell and Interactive Investor run 5-15p per £100 nominal on liquid issues. That is 0.05-0.15% round-trip. On a hold-to-maturity position it is paid once. A fund's 0.05-0.07% OCF is paid every year you hold.

Pick three or four gilts spanning your time horizon — a 2028, a 2031, a 2035 — and you have built a ladder that does not need management. Each gilt has a known redemption date and a known cash flow. There is nothing to rebalance. The fund's value proposition is "we rebalance for you", but a ladder held to maturity needs no rebalancing.

Buying gilts direct does mean placing a trade over the phone or using a dealer on your platform's website. It is not the one-click experience of buying VGOV. But the Debt Management Office publishes every gilt in issue, redemption dates, and coupons. The data is free and the product is government debt — there is no credit analysis to do.

For a walkthrough of how to actually execute a trade, see our practical guide to buying gilts and our analysis of current gilt yields for context on where the curve sits.

Not every investor benefits from going direct. Two cases where the fund is the right answer:

Inside an ISA or SIPP. The CGT exemption is moot — everything inside the wrapper is already CGT-free. Here the fund's daily liquidity, dividend reinvestment, and diversification across the curve are genuine conveniences worth the 0.05% OCF.

Pot size under £25,000. Below that you probably cannot buy more than one or two individual gilts without concentration risk on maturity timing. A fund smooths that out. And the CGT exemption saves you less in absolute pounds because the gain itself is smaller.

Everywhere else — a higher-rate or additional-rate taxpayer with five-figure-plus taxable savings, planning to hold to maturity — the fund is a service you are paying for annually to avoid a one-off afternoon's work. For the opposite view, our fund-first debate piece argues the £7 OCF is a trivial price for hands-off bond exposure. For the tax edge on direct gilts, see our guide to buying gilts in the UK and the gilts hub for live yields.

If gilts can pull up to par tax-free, they can also pull down below cost. That capital loss is not relievable against other gains. You do not get the asymmetric benefit of the CGT exemption — you pay no tax on gains, and you also claim no relief on losses.

In practice this matters less than it sounds. Buy a gilt below par, hold to maturity, and you will receive face value unless HM Treasury defaults. So the pull-to-par is mathematically guaranteed for anyone who does not sell early. The risk only bites if you are forced to sell at a loss before maturity — which is exactly the scenario a ladder is designed to avoid.

With ONS headline CPI at 3.0%, real yields on a gilt bought at today's levels remain positive even after coupon tax for a basic-rate payer — another argument against shortening duration purely to reduce tax exposure.

And the coupon income you receive along the way is still taxable as interest. You are only exempt on the capital portion. For an investor who wants pure exemption, a very-low-coupon gilt acquired below par — where the capital portion is most of the return — maximises the structural advantage.

For related allowance planning, see the ISA guide and our savings hub. And if you are weighing gilts against other safe-haven options, our gilts vs cash savings debate covers the inflation math.

This article is for informational purposes only and does not constitute financial advice. Capital Gains Tax and income tax treatment depends on individual circumstances and may change. You should seek independent financial advice before making any investment decisions.