State Savings vs Bonds: Protection and Taxation

[Tastebuds]

According to the NTMA "the repayment of all State Savings money is a direct, unconditional obligation of the Government of Ireland".

Is that also the case with Irish Government Bonds?

Are there any differences in taxation between State Savings and Bonds?

Thanks

 

[Protocol]

Yes is the answer to both questions.

 

[Tastebuds]

Thanks Protocol

So, there are differences in taxation?
State Savings are tax-free. Are Government Bonds not tax-free for Irish Residents?

Thanks

 

[jpd]

Interest income from Gov't Bonds is taxable but any Capital Gains are not - but then any Capital Losses cannot be offset against other gains.

 

[Tastebuds]

Ok. I see. Thanks

Am I missing something? Or Gov't bonds are a way better option than Bank Deposits if you are happy to lock your cash for a few years?

• Taxation: both are taxed: income (bonds) vs DIRT
• Interest: Gov't interest are way better than bank deposits
• Protection: full protection (bonds) vs 100k max

Thanks

 

[jpd]

If you are able to lock up your money for the duration of the bond, then yes.

But if you need to sell your bond at some time before the redemption date, you could end up with a loss of capital - which could be significant, if interest rates rise between now and the date of sale.

Generally, private investors cannot buy new bonds as they are issued but have to buy them on the secondary market which involves transactions costs and custody costs.

For example - the 1% Treasury Bond with a redemption date of 15/05/2026 has a market price of around € 99.50 for € 100 today. It will pay 1% for the next 9 years and be repaid in full € 100 in 2026

 

[Tastebuds]

Generally, private investors cannot buy new bonds as they are issued but have to buy them on the secondary market which involves transactions costs and custody costs.

I did not know that...

So, how do bond ETFs work? When you buy them there is not concept of "maturing", they just keep tracking...

Thanks

 

[Tastebuds]

Interest income from Gov't Bonds is taxable but any Capital Gains are not - but then any Capital Losses cannot be offset against other gains.

I cannot fully understand how CG affects Gov't bonds

Say you buy a Gov't bond and you hold it until maturity... at that stage, the face value is returned to you. So, even if CG was taxed there will be 0 CG?

When we say that there is no CG with bonds. Is that for the case when you sell the bonds before maturity and you make a profit between the market value and the face value you paid?

Thanks

 

[Duke of Marmalade]

Say you buy a Gov't bond and you hold it until maturity... at that stage, the face value is returned to you. So, even if CG was taxed there will be 0 CG?

If you had bought the bond at 90% of face value you make a CG. Bottom line is that State Savings are always better than govie bonds for the ordinary punter.

 

[Tastebuds]

If you had bought the bond at 90% of face value you make a CG. .

Yes, that makes sense

How do bonds start selling on the secondary market? Is there a known date that an investor can use to ensure buying the bonds at face value at day=1 of the bond? Just to keep it simple, get the face value you invested returned at the end of the maturity and only care about the interest?

Thanks

 

[Gordon Gekko]

A bond has a maturity/redemption date. It might be referred to as a "May 2020". So in May 2020 the State or (say) Digicel promises to give you back your €100. The robustness of that promise (and other factors) then dictate the price, which is constantly changing. Irish State debt is more desirable than Digicel debt, so the markets price them accordingly.

 

[Tastebuds]

A bond has a maturity/redemption date. It might be referred to as a "May 2020". So in May 2020 the State or (say) Digicel promises to give you back your €100. The robustness of that promise (and other factors) then dictate the price, which is constantly changing. Irish State debt is more desirable than Digicel debt, so the markets price them accordingly.

Yes, I am thinking about the case where the investor is not interested in the bond prize fluctuation that comes with trading in the exchange. Just interested in the interest. So, you buy at face value and keep to maturity

I think that @jpd already answered this question, but it is annoying that there is no way to buy those bonds over the counter... like state savings: no single exchange on which they trade...

 

[Gordon Gekko]

You can buy them through a stockbroker. Inflation is likely to be the killer. And what about the risk of a default in the form of a redomination of the Euro debt into Punts?

 

[Tastebuds]

You can buy them through a stockbroker. Inflation is likely to be the killer. And what about the risk of a default in the form of a redomination of the Euro debt into Punts?

If Ireland rolls back to the Punt but the EURO does not die and other countries keep using it... your investment could not be renominated I think.
If the EURO disappears completely that is a different story

 

[PMU]

If you had bought the bond at 90% of face value you make a CG.

Yes but it does not give rise to a charge for CGT. Revenue says: "not all disposals (of assets) give rise to a charge of CGT. For example, any gains arising in the following circumstances are not regarded as giving rise to chargeable gains and hence are not liable to CGT - Gains on Government Stocks and other securities (e.g. securities issued by certain semi-State bodies)." [broken link removed]

 

[Duke of Marmalade]

PMU there is no CGT on Irish Govies, that has been established earlier. Tastebuds seemed to be querying how there could be CG, given maturity at face value - I was pointing out that that is clearly possible.

But let us scotch all this talk of Govies versus State Savings once and for all. Let us compare (A) 5 year Savings Certs with, say, (B) 5.4% 03/25.

(A) give a return of .98% tax free
(B) gives a return of .85% gross, of this .85% 3.25% (sic) is subject to income tax and the balance of -2.4% capital loss gets no CGT relief. The net return is c. -2% p.a. and that is before building in costs.

What's more, if interest rates rise and the smart money seems to be on that scenario, you can exit (A) without loss and re-enter at the new yields.

I can see no scenario whatsoever where today's Govies would be superior to State Savings for the ordinary punter.

 

[Tastebuds]

(B) gives a return of .85% gross, of this .85% 3.25% (sic) is subject to income tax and the balance of -2.4% capital loss gets no CGT relief. The net return is c. -2% p.a. and that is before building in costs.
.

Thanks a lot for the illustrative example. It does seem that state savings are more flexible at today's low interests. I am not sure I fully understand where the (B) numbers come from, so I would like to be sure I am fully getting this:
- The .85% is that today's yield to maturity? I checked the Irish stock exchange and it is 0.68 %
- Why only 3.25% is subject to income tax and not the whole interest return?

Thanks!

 

[Duke of Marmalade]

It was 0.85% in Thursday's IT, but price has risen slightly since

5.4 is the coupon (interest) but the price is 135 so that represents 3.25% (5.4/135) interest yield.

Of course more recent govies have much lower coupons and so do not suffer from this massive CGT anomaly for the ordinary punter, all the same I wouldn't touch them with a 40 foot pole

 

[Duke of Marmalade]

Ooops! 5.4/135 = 4