[PB Notebook] If You’re Worried About the ‘Bankdemic,’ How About Investing in Government Bonds?

Recently, inquiries about government bonds have been increasing. This is because, amid unsettling news about financial institutions?such as the bankruptcy of Silicon Valley Bank (SVB), the merger of Credit Suisse (CS) into UBS, and rumors of a Deutsche Bank crisis?attention has shifted to bonds considered slightly safer than the corporate bonds that have been actively sold since last year. Additionally, although U.S. interest rates are still on the rise, growing concerns about an economic recession have led to a perception that the benchmark interest rate hikes have peaked, which has also influenced this trend. In this context, government bonds currently available at a discount offer several attractive features.

The appeal of government bonds as discount bonds is as follows. First, government bonds are stable. They are bonds issued by the Republic of Korea government for the purpose of project execution or fundraising. In principle, government bonds, like other bonds, carry a risk of default. However, they are generally perceived as safer than bank deposits, providing psychological reassurance in times of uncertainty like the present.

Next, purchasing government bonds at a discount offers not only additional interest benefits but also tax advantages. Although the coupon rate itself is lower compared to time deposits, buying at a discounted price means that, considering the discount rate, the average annual yield can be comparable to that of time deposits. For example, a 3-year government bond issued with a coupon rate of around 1.2% can be purchased at a discount of about 2.2% (as of the 27th). Even by simple arithmetic, a government bond buyer can gain approximately 3.4%. Therefore, when discussing bond yields, it is common to refer not to the coupon rate printed on the bond but to the trading price of the bond in the market.

Furthermore, under current tax laws, capital gains from bond trading are tax-exempt, resulting in a very low taxable base compared to the amount received. Assuming an investment of 1 billion KRW, the total amount received would be about 30 million KRW, but the taxable base would be around 10 million KRW. This creates a tax-saving effect of approximately 20 million KRW.

Lastly, if the comprehensive income tax base is high, the effective yield on government bonds increases further. Amounts exceeding 20 million KRW in financial income must be combined with other comprehensive income and are subject to additional taxes. For taxable income over 88 million KRW, the additional tax rate ranges from 35% up to a maximum of 45%.

The tax exemption on capital gains from bonds reduces this tax burden, thereby increasing the effective pre-tax yield. For example, a government bond with about 1 year and 3 months remaining until maturity can yield a pre-tax return of about 3.3% when converted to a bank time deposit rate for a generally taxed customer. However, for customers in the highest tax bracket of 45%, the effective pre-tax yield can be about 5%. Government bond investments are typically made through banks and securities firms, with treasury bonds being the most actively traded among various government bonds.

As of the 27th, if you purchase a government bond with about 1 year remaining to maturity for 100 million KRW, it can typically be bought at a discounted price of about 98 million KRW, reflecting a 2.2% discount. This bond will mature at 100 million KRW, and interest is paid every six months. Interestingly, the accrued interest from the previous interest payment date to the subscription date is also tax-exempt. Since the seller pays the tax on this accrued interest when selling the bond, the buyer does not have to pay this tax, resulting in a tax-exempt benefit.

Due to the higher interest rates last year, many investors became subject to comprehensive taxation on financial income. Additionally, some had to pay extra health insurance premiums accordingly. At a time when concerns about financial market instability are rising, with even a new term “Bankdemic” (bank + pandemic) emerging, government bond investment, which combines stability and tax benefits, is considered a sufficiently attractive investment option.

Kim Daesu, Head of PB Team, Shinhan PWM Yeouido Center