What are T-bills and how do they work?

Treasury bills or T-bills are government bonds with a short time until they mature – known in industry jargon as ‘short-dated’. They come with a minimum maturity of one day and a maximum maturity of 364 days, but in reality, most T-bill have maturities of one month, three months or six months.

Like Government bonds, or gilts, they are loans to the government and therefore have a very high level of safety, as you are guaranteed your money back unless the UK government defaults on its debts, which is extremely unlikely.

Unlike gilts, they don’t come with any income attached. The investment return comes solely from the difference between the price at which the government sells the bond to investors and the redemption price when the government pays them back.

Another important thing to consider is that Treasury bills are not traded on the secondary market, which means you can’t sell it on to someone else in the same way you can with shares or some other bonds. It means if you buy one you have to hold it until maturity, so you must be certain that you won’t need access to your money in that time.

What determines the return on T-bills?

T-bills are sold by a process of an auction from the UK’s Debt Management Office on a weekly basis, so the price is set by supply and demand through the bids that institutional investors, like pension schemes and fund managers, offer. In reality, the offers that these professional investors make are likely to be based on the interest rates they can get on other short-term assets, and so will be heavily influenced by the Bank of England’s base rate. If the Bank cuts the base rate, this will tend to dampen the returns provided by T-bills at auction. However, if you already hold a T-bill, your return isn’t affected, as you will still receive the same maturity value.

What are the risks of Treasury bills?

There’s an extremely low chance that the UK government will not pay back the money they owe through Treasury bills, so they are very safe from this point of view. They do come with some risks, though, including the following:

• Inflation risk: inflation might be more than the return provided by the T-bill, which could mean your money actually losing its buying power. This is common to all fixed interest investments, unless they have a specific inflation-link attached.
• Interest rate risk: if interest rates rise just after you have bought the T-bill, the return you’re getting might look less attractive by comparison. However, this risk is mitigated to a large extent by the short-dated nature of T-bills. Ultimately if rates rise, you don’t have to wait too long to get your money back, at which point you can put it to work getting a higher return.
• Reinvestment risk: there’s a risk that you may not be able to achieve a similarly favourable rate when your T-bill matures. If interest rates fall while you’re invested, at maturity you’ll probably get a lower rate if you roll over into another T-bill. By contrast, if you buy a government bond that is longer dated, you lock into its yield for a longer period. Depending on how interest rate expectations move, that could end up being better or worse than the return achieved by buying a series of T-bills.

What is the tax treatment of T-bills?

Many people have been buying low coupon, short-dated gilts in recent years, because most of the returns from these instruments are capital gains, and gilts are not subject to capital gains tax. It’s important to recognise though that the tax treatment for T-bills is very different. They are taxed as what are called ‘deeply discounted securities’, which means the returns you make are taxed as income, even though intuitively they look like capital gains. So, you will potentially be subject to income tax on your return. Happily, though, Treasury bills can be held in a Stocks and shares ISA or a SIPP, where the gain can be harvested tax-free.

Learn more about bonds and gilts