Bonds and corporate bonds explained

A bond is, at its heart, a loan that you make to a government or a company. As Which? puts it, "a corporate bond is effectively a way of lending money to a company"¹. The borrower promises to pay you interest on the loan at set dates and to hand back the amount you lent when the bond ends. In exchange for that promise, you take on the risk that the borrower cannot pay.

Governments and companies issue bonds to raise money without going to a bank. A government bond issued by the UK Treasury is called a gilt, and gilts are "government bonds often favoured by investors making long term investments"². Companies issue corporate bonds for the same reason: to borrow directly from investors rather than from a bank.

A bond is a loan to a government or company

When you buy a bond, you become a lender rather than an owner. That is the key difference from a share: a shareholder owns a slice of a company and shares in its fortunes, good or bad, while a bondholder has lent money on fixed terms and stands near the front of the queue if things go wrong. The company or government that issued the bond owes you a debt, and it must pay that debt before it can pay dividends to shareholders.

The terms of the loan are set out when the bond is issued: how much interest will be paid and when, and the date the loan ends, known as the maturity date. Unlike a savings account, where the bank can change the rate, the payments on a fixed rate bond are written into the bond itself. The Bank of England notes that high-yield bonds, the riskier corporate bonds sold by companies with weaker credit, are fixed rate⁶. That certainty of income is the main reason investors buy bonds, and the risk that the borrower fails to pay is the main reason bond returns are higher than simply holding cash.

Most people who hold bonds do not lend to a single borrower. A bond fund spreads your money across many issuers at once: as Which? explains, "with a bond fund, you might be invested in as many as 200 different bonds"³. That spreading matters because a single company defaulting hurts far less when it is one loan out of two hundred than when it is the only loan you made.

Gilts and corporate bonds: who issues them

Bonds are named after who borrows the money. Gilts are bonds issued by the UK government, and they are "government bonds often favoured by investors making long term investments, such as equity release providers"². Because the UK government has never failed to pay a gilt in modern times, gilts are treated as the safest sterling bonds, and other bonds are measured against them. The dedicated guide to gilts covers how they are bought and sold.

Corporate bonds are issued by companies. Which? describes them as "effectively a way of lending money to a company"¹. Companies of every size and credit quality issue them, from large, established businesses to smaller and riskier ones, and the interest they offer generally rises with the risk that the company cannot repay. High-yield bonds, the riskier end of the corporate bond market, pay a fixed rate⁶.

Between and around these sit other issuers: local authorities, supranational bodies and, in the retail market, products from NS&I, the government's savings arm, which sells savings products described as bonds but working as deposits (covered below). There are also insurance bonds, which are quite different again: entitledto describes an insurance bond as "technically a single premium investment which often includes a relatively small amount of life insurance, usually purchased from a major insurance company"⁷. Those are covered on the investment bonds page.

Not the same as a bank's fixed-rate savings bond

The word "bond" causes more confusion than almost any other in personal finance, because banks and building societies use it for savings accounts. MoneyHelper is clear: "fixed-rate savings bonds are interest-paying savings accounts offered by banks and building societies for a fixed amount" of time⁸. They are deposits, not investments. Your money is a deposit with the bank, the rate is fixed for the term, and the term runs "between six months and five years"⁸. You usually get a higher rate than on instant access savings, and the longer you lock your money in, the higher the rate is likely to be⁸.

These savings bonds have their own rules: most do not allow further deposits after the opening one, and "there can be big penalties for early withdrawal"⁸. You can buy them "directly from a bank or building society or National Savings and Investments (NS&I)", online, in a branch, by post or by phone depending on the provider⁸.

NS&I's own products sit in this savings family. Premium Bonds, for example, pay no interest at all: instead, "each £1 Bond you hold is entered into a monthly prize draw, giving you the chance to win tax-free prizes"⁹. British Savings Bonds are another NS&I deposit product, sold in issues, where "your money will be 100% secure, backed by HM Treasury"¹⁰. None of these is a tradeable investment bond. The distinction matters most for protection: NS&I savings products are backed by HM Treasury rather than the FSCS¹⁰, while bonds bought as investments have no such protection, as explained near the end of this page.

How you earn from a bond: coupons and repayment at par

A bond pays you in two ways. The first is the coupon: a fixed interest payment, usually made once or twice a year, expressed as a percentage of the bond's face value. The second is repayment at par: when the bond matures, the issuer pays back the face value of the loan, typically £100 per bond. A bond bought at launch, held to maturity and repaid at par has a known outcome in advance, which is what separates it from a share.

The yield is the return a bond gives you, worked out from the coupon and the price you pay. If you buy a bond at less than its face value, your yield is higher than the coupon, because you still get repaid the full face value at maturity. If you buy above face value, the reverse applies. The comparison page on yield versus total return covers how these measures differ.

Accrued interest is the interest that has built up on a bond since its last coupon payment. If you buy a bond between coupon dates, you normally pay the seller the accrued interest on top of the bond's price, and you then receive the whole of the next coupon. This is why bond prices are often quoted "clean" (without accrued interest) while the amount you actually pay is "dirty" (with it).

Some products roll the interest up instead of paying it out. NS&I's Guaranteed Growth Bonds add interest to the bond and pay everything at the end: the interest is taxable "in the tax year your Bond matures"¹². At maturity, NS&I writes to holders "around a month before your Bonds mature explaining the options available to you"¹³, and for Guaranteed Income Bonds the options include automatically renewing "for another term of the same length", renewing for a different term, or cashing in¹⁴.

Why bond prices rise and fall

Between issue and maturity, a bond has a market price, and it moves constantly. The price reflects what investors will pay today for the bond's future stream of coupons and its repayment at par. When new bonds come to market paying more interest, older bonds with lower coupons become less attractive and their prices fall; when new bonds pay less, older higher-coupon bonds rise in value. This is why bond prices generally move in the opposite direction to interest rates.

Prices also move with the issuer's creditworthiness. If a company's prospects darken, investors demand a higher return to hold its bonds, which pushes the price down. And prices move with the general level of risk in the market: Which? lists the systemic risks that hit all investments at once as including "interest rates, inflation, wars and recession"³.

The practical consequence is simple: if you sell a bond before it matures, you may get back more or less than you paid. A bond held to maturity from launch avoids that price risk (though not the risk of default), but a bond sold early does not. The government's ISA reform rules underline how bonds differ from money: individual shares, funds, investment trusts, exchange-traded funds and "corporate and government bonds, including UK gilts" are expressly not cash-like assets¹⁵. A bond may feel like a savings account, but its value is not fixed until the day it matures.

Credit ratings and the risk of default

The biggest single risk to a bondholder is default: the borrower failing to pay the coupons or repay the loan. Credit rating agencies grade issuers on this risk, and the market prices it in, which is why riskier companies must offer higher coupons to attract lenders. High-yield bonds, the market's name for the riskier corporate bonds, pay a fixed rate⁶.

How bad can default be? The FCA's own risk summary for high-risk bonds sold on platforms states plainly: "investors in these shares or bonds often lose 100% of the money they invested, as most start-up businesses fail"¹⁶. That warning was written for the riskiest end of the market, but it shows the shape of the risk: a bondholder is an unsecured creditor of the borrower, and if the borrower's money runs out, the bondholder's claim may be worth little or nothing.

There is no compensation scheme that pays bondholders back when a company defaults. Which? notes that if you put money into unregulated investments, "you won't be covered by the FSCS, unless the investment was the result of negligent advice from an independent financial adviser"⁵. The protection that exists covers bad advice and failed firms in certain circumstances, not investment losses, as the investment risk and FSCS pages explain.

Other risks: interest rates, inflation and early repayment

Beyond default, three further risks shape what a bond is worth to you.

Interest rate risk. If rates rise after you buy, the market price of your bond falls, and anyone forced to sell early crystallises that loss. This is the mirror image of the price behaviour described above, and it applies even to borrowers who never miss a payment.

Inflation risk. A bond pays fixed amounts, and fixed amounts buy less each year if prices rise. MoneyHelper makes the point about fixed-rate products generally: "your original investment won't hold its value in real terms (its 'buying power') if the interest you're getting is less than the rate of inflation over the investment period"⁸. Which? makes the same point about portfolios heavy in bonds and cash: they are lower risk, "but leave your money vulnerable to being eroded by inflation"³.

Access risk. Some bonds cannot be sold or cashed in at all before maturity. NS&I's Green Savings Bonds are explicit: "the Bond is designed to be held for the whole term. You can't cash it in before the end of the term"¹⁷. Early repayment can also work the other way: some issuers repay bonds early when it suits them, cutting short the income you expected. The general lesson from credit markets is that the terms of the individual bond, not the label on it, decide what happens.

Bonds compared with cash and shares

Bonds sit between cash and shares on the risk spectrum. Cash is a deposit: the nominal value does not fall, but inflation can eat its buying power. Shares are ownership: their value swings widely with the company's fortunes. Bonds are a loan: the income is fixed and the borrower is legally obliged to pay, but the price before maturity moves, and the borrower might default.

Which? frames the trade-off in portfolio terms: a portfolio weighted towards bonds and cash carries lower risk, but leaves money exposed to inflation, while a portfolio weighted towards shares carries more risk in exchange for higher expected growth³. The government's ISA rules reinforce the dividing line: corporate and government bonds, including UK gilts, are classed as investments, not cash-like assets¹⁵.

Who tends to suit what? Cash suits money needed in the short term or money that cannot be put at risk. Shares suit long-term money that can ride out falls. Bonds tend to suit money in between: investors who want a known income and are prepared to accept some price movement and default risk for it. The bonds versus equities comparison and the guide to diversification and asset allocation develop this.

Tax on bond interest

Interest from bonds and gilts is normally paid gross, with no tax deducted at source, and it counts towards your Personal Savings Allowance. Which? sets out the thresholds: income tax applies to interest from bonds and gilts "above £1,000 a year (basic rate taxpayer) or £500 (higher-rate) or £0 (additional-rate)"⁴. Because tax is not deducted for you, you may need to declare the interest to HMRC yourself.

NS&I's product terms show how this works in practice. On Income Bonds, "we pay your interest without deducting any tax. However, the interest is taxable so it will count towards your Personal Savings Allowance"¹⁸. The same wording appears for Guaranteed Income Bonds¹⁹ and in the Income Bonds brochure, which adds that "taxpayers may need to declare the interest to HM Revenue and Customs (HMRC), depending on your circumstances"²⁰. Guaranteed Growth Bonds add interest without deducting tax, and the interest is taxable income for UK income tax purposes²¹. Green Savings Bond interest is likewise taxable¹⁷.

Two things can change this picture. The first is holding bonds inside an ISA, where interest is free of income tax. The second is Premium Bonds, which pay prizes rather than interest and are "tax-free" by design⁹. The tax on investments page covers the wider rules, including capital gains when a bond is sold for more than you paid.

Holding bonds in an ISA or SIPP

Bonds can be held inside tax wrappers. Corporate bonds can be held in a stocks and shares ISA¹, and gilts can too. Inside an ISA, coupon interest is free of income tax, and inside a SIPP it is sheltered until you draw it. NS&I also offers its own cash ISA, the Direct ISA, alongside its deposit products²².

The wrapper does not change the investment. A corporate bond in an ISA is the same loan with the same default risk as one held outside; the ISA only changes the tax. It also does not make an unsuitable investment suitable, and the ISA reform rules confirm that corporate and government bonds, including UK gilts, are treated as investments rather than cash for the purposes of what can sit in a wrapper¹⁵.

For most people, a bond fund inside a wrapper is the practical route in, because a fund spreads the lending across many issuers, as many as 200 different bonds in one fund³. The pages on investment funds and where to hold investments cover the choices.

Limits on how much you can put in

For market bonds bought through a broker, there is no overall cap on how much you can lend, though each bond has a minimum purchase size and each issue a finite amount to sell. The limits that consumers most often meet are the ones set by NS&I on its own products, and they vary widely:

Guaranteed Growth Bonds allow "up to £1 million per person (or £1 million per trust), in each Issue of each term (but there is no limit if you reinvest a Bond when it matures)"²¹. For children, the cap is firm: a child "can only have up to £50,000 of Premium Bonds in total"²⁶. The ISA allowance is a separate limit on how much new money can go into wrappers each year, covered on the ISAs page.

Selling before maturity

Whether you can get your money out early depends entirely on the bond. Tradeable gilts and listed corporate bonds can be sold on the market at any time it is open, at whatever the price is that day, which may be more or less than you paid. NS&I's variable products, such as Income Bonds, allow withdrawals on demand. But NS&I's fixed-term products generally do not: Green Savings Bonds "can't be cashed in before the end of the term"¹⁷, and the same design runs through the Guaranteed Growth and Guaranteed Income ranges.

What happens at the end of the term is set out in advance. NS&I contacts Green Savings Bond holders "to let you know your options at least 30 days before your Bond matures"²⁷, and writes to Guaranteed Growth and Guaranteed Income Bond holders "around a month before your Bonds mature explaining the options available to you"¹³. For Guaranteed Income Bonds the options are to renew automatically for the same term, renew for a different term, or cash in¹⁴. Premium Bond prizes can be "paid directly to your bank account or reinvested into more Bonds"²⁸.

No FSCS protection for bonds you buy

The Financial Services Compensation Scheme "protects customers of authorised financial services firms if they fail or have stopped trading"²⁹. It covers some products when a regulated firm fails, but it does not cover the performance of investments you have bought. Bonds and gilts are not covered by the FSCS, and repayment of bonds is not guaranteed¹². Corporate and UK government bonds have no such protection¹².

The FSCS's own material is blunt about what falls outside. Most cryptoassets are not protected because they are not regulated³⁰. PayPal has no FSCS protection³¹. Whole classes of insurance claims are not eligible, including goods in transit, marine, aviation and credit insurance³², and contracts of reinsurance³³. In the Dolfin failure, the FSCS stated it "will not compensate customers in relation to any client money shortfalls that derive from or were intended for use in any of the T1IV Bonds"³⁴. The FSCS's consumer leaflet likewise notes that it does not protect money paid under arrangements outside its scope, such as individual voluntary arrangements arranged by insolvency partners not regulated by the FCA³⁵.

For bonds, the position is this: if you buy a bond and the issuer defaults, or the price falls and you sell at a loss, the FSCS does not pay. Which? notes the exception: you are not covered for unregulated investments "unless the investment was the result of negligent advice from an independent financial adviser"⁵, in which case advice-related compensation may be available. The FCA's risk warnings for high-risk bonds reinforce the point, stating that the FSCS "doesn't protect this type of investment because it's not a type of investment that the FSCS can protect"¹⁶. The pages on what happens if a platform fails and FSCS and poor performance draw the line precisely.

Where to get help

Free, impartial help is available. MoneyHelper, the government-backed money guidance service, publishes plain explanations of savings bonds and how they differ from investments⁸, and Which? sets out your rights as an investor, including when you may be able to complain⁵. If you were sold a bond on the basis of bad advice from a regulated adviser, you can complain to the firm and then to the Financial Ombudsman Service, and the bad investment advice page explains how.

If a bond or the firm behind it has failed, the FSCS sets out what it does and does not cover, and its publication scheme rules are the authoritative source on eligibility²⁹. For anything that looks too good to be true, the investment scams page lists the warning signs, and the FCA's rules on marketing high-risk investments, including the ban on marketing speculative mini-bonds and loan notes to retail investors since 2021, are covered on the high-risk investment rules page.