Gilts bonds issued by the UK Government when it borrows money on the financial markets have been hitting the headlines in recent weeks, with a surge in yields to levels not seen since the late 1990s posing a risk to Chancellor fiscal plans.

While the rise in costs for the UK Government is clearly bad news for the Chancellor, it creates an opportunity for cautious investors and savers, and especially for those subject to the higher rates of tax.

If they are able to invest in gilts, they could earn up to 7% on their cash, so long as they are prepared to leave it in the gilt for a few years.

More than two million UK savers are expected to pay tax on their cash savings interest in the 2024/25 tax year - three times more than in the 2021/22 tax year.

Jason Hollands, managing director at wealth management firm Evelyn Partners, says this now means that many people with a decent level of savings outside of ISAs and pensions risk an unwelcome tax bill.

He said: "When the Personal Savings Allowances (PSA) of £1,000 and £500 pa respectively for basic and higher rate taxpayers was introduced many years ago at a time of rock-bottom interest rates, most savers didn't have to worry about paying tax on the interest from their cash savings as - even as a higher rate taxpayer - you'd have needed very large deposits to test those levels.

"But with savings rates now at around 4.5-5.0%, hundreds of thousands more savers are either paying tax on their cash savings interest, or close to doing so."

Mr Hollands said: "The obvious shelter is a cash ISA but some savers might quickly use up their annual £20,000, or prefer to use the allowance for longer-term investments such as stocks and shares, so it is important to have other strategies to minimise the amount paid in tax on cash savings.

"But for those already maximising ISAs and with sizeable savings in a taxable environment that they don't need immediate access to, investing in gilts is an attractive option, especially now that yields are at levels not seen for many years."

Mr Hollands added many people who are unfamiliar with gilts and the wider bond markets might assume, when reading about the 'yields' available, that these are equivalent to interest payments. He said: "However, in the case of gilts and bonds that have already been issued and are traded on the financial markets, the 'yields' available will represent a combination of the expected capital returns if held until maturity as well as the interest they pay out, which is then annualised.

"Investing in gilts directly - rather than through funds - offers investors who hold them until maturity a very predictable return, because investors know the current price they can buy at and the amount they will eventually be repaid at a known date in the future, as well as the interest payments they will receive in between."

Mr Hollands said were issued during the period of ultra-low pay very low levels of fixed interest, but these are currently available at nominal prices significantly below the level they will be redeemed at on maturity.

This means that the lion share of the "yield" they offer will come through a capital gain rather than the level of fixed interest - also called a coupon in city speak - that they pay.

Gilts are exempt from capital gains tax. This makes gilts with low coupons, which are trading below their redemption prices, especially attractive for higher and additional rate taxpayers.

Mr Holland said: "For example, there is currently available a gilt that is due to mature on 31 January 2008 at £100.

"While it only has pays a low coupon of 0.125% on the nominal price it was issued at - because it was originally issued in June 2020 when UK were at an all-time low - the cost of this Gilt on the market is currently £88.689, so an investor buying today knows they will make a capital gain if they hold to maturity in three years when it redeems at £100.

"The expected gain, combined with the small amount of fixed interest that will be paid out, in this case equates to an annualised 'yield to maturity' of 4.124%.

"Unlike the seemingly higher cash available, which are variable and may decline over the next few years, this return is predictable and can be effectively locked-in now.

"But further, as most of this 'yield' will come from a tax-free capital gain, this is very attractive to a higher or additional rate taxpayer compared to a cash savings account.

"The after-tax return each year for a 40% taxpayer for this gilt is equivalent to 4.07% and for a 45% taxpayer it is 4.06%.

"To get such a post-tax return from a cash savings account would require a 40% taxpayer to find an effective headline of 6.78% from a bank or building society and for those subject to the 45% tax-band, they would need secure a pre-tax of 7.389%.

"Such rates on cash savings accounts are obviously not available, nor anything close."

Mr Hollands said gilts are considered to be extremely safe but prices will move up and down on the secondary market as views change on the outlook for inflation,

He said: "Investing directly in the bond markets, including gilts, can therefore be fairly complex territory as prices and yields can change from day to day, so expert help is required: those considering gilt investments, whether it is to reduce their tax liability on cash savings or to establish a flow of income in retirement, should therefore take advice from a financial adviser or wealth manager."