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Do you prefer the idea of a guaranteed interest payment on savings, or the chance of winning a prize draw? The latter, in simple terms, is what Premium Bonds offer. Yet are they a good deal?
Below, our Padiham financial advisers explain how this investment from NS&I works, how it compares to cash savings accounts and ways that the former can integrate into a financial plan.
We hope these insights are helpful to you. Please get in touch for more information or to discuss your own financial plan with us.
What are Premium Bonds?
Premium Bonds are a type of savings account which offers the saver a prize draw, not an interest payment. They are offered by National Savings & Investments (NS&I) – a state-owned savings bank in the UK – and provide monthly cash prizes worth up to £1 million.
Each month, 2 million prizes are handed out to various bondholders. An individual can buy up to £50,000 in Premium Bonds, with the minimum purchase amount set at £25. Any UK resident age over 16 can buy them, although under-16s can do so if they nominate a parent/guardian to hold them until they reach legal age.
Premium Bonds are different from UK government bonds (gilts). The former is similar to a regular savings account in many ways. The latter, however, is a type of “I.O.U” given to an investor when he/she agrees to lend money to the government, with interest.
How do they compare with cash savings?
In 2023, rates on cash savings accounts have been rising as the Bank of England (BoE) has raised its own base rate. This has increased the incentive for people to save, although savings rates are still largely below official measures of inflation (6.8% in the year to July).
This means that many cash savers continue to lose money, in real terms, despite the interest indication on their bank statements. Premium Bond, by contrast, could allow investors to achieve a far higher return – potentially matching, or even beating, inflation.
The problem, however, is that Premium Bond investors have a very low chance of winning anything at all. Although the odds are the highest in 15 years, the odds are still 21,000 to 1 each month that you win even the smallest prize of £25.
Of course, the more Premium Bonds you own, the more likely you are to win a prize. For instance, the median prize rate is 2.75% for someone with £10,000 invested into Premium Bonds. For someone investing the maximum £50,000, the rate is 3.2%.
These calculations assume that investors have “average luck” in their winnings. Of course, an individual may be far less lucky, or more so, depending on chance. Therefore, Premium Bonds vary in suitability depending on their investor’s preferences, to a high extent.
If you are more of a “risk taker” and do not mind missing out on the chance to earn guaranteed interest from cash savings, then Premium Bonds may be an attractive option. Conversely, if you want the peace of mind that your money will gain interest (albeit likely at a rate below inflation), then cash savings may be preferred.
How Premium Bonds can feature in a financial plan
Premium Bonds can be useful to help achieve goals in your wider financial plan, such as mitigating needless tax on your savings and investments.
For instance, suppose you are a Higher Rate taxpayer and you want to build up your savings. In 2023-24, you can earn up to £500 in interest each tax year. Based on today’s average savings rates, it may only take £10,000 in savings to tip you over the tax-free threshold.
However, by investing in Premium Bonds, an individual could avoid this outcome – or minimise the tax “damage”. This is because the prize draws offered by NS&I do not technically count as interest. Indeed, the prizes are received completely tax-free.
Of course, another option to mitigate tax on interest from cash is to use a cash ISA. Each tax year, you can contribute a total of £20,000 to your ISAs – where any dividends, capital gains and interest are generated tax-free.
Savings in Premium Bonds can be accessed immediately, similar to easy-access cash savings. This means that they can be suitable for storing emergency funds (e.g. 3-6 months’ worth of living costs).
Premium Bonds are also guaranteed by the Financial Services Compensation Scheme. However, this is also the case for savings held in a UK bank account, up to £85,000.
As a general rule, cash savings accounts are likely to be a better bet for those with “average luck” and who do not earn interest over their Personal Savings Allowance. However, if you do achieve this level of luck and pay tax on your savings, Premium Bonds may be a better option.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you.
Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
