Q. I have held £46,000 in Premium Bonds as an easily accessible rainy-day fund for the past three years, with the added bonus of some tax-free returns. It was easy and familiar; it used to be that most months I would get about £100 to £200 worth of prizes, which, while not the best return I could get on the money, was enough to keep me happy. But this year has not been successful and the past few months I haven’t won anything at all. Are Premium Bonds still worth it or is it time I moved elsewhere? Stephen, Epsom
Premium Bonds, run by the treasury-backed bank National Savings and Investments (NS&I), have long been the nation’s savings sweetheart. They’re popular because of their unique proposition: the chance to win prizes, including two £1 million jackpots each month, tax-free. But like any financial products, they come with advantages and disadvantages that need to be carefully weighed.
You rightly say that one of the most compelling features of Premium Bonds is the tax-free nature of any winnings. This can be particularly advantageous for higher-rate taxpayers who might otherwise pay tax on a significant portion of their savings interest in traditional savings accounts.
Basic-rate taxpayers can earn up to £1,000 a year interest before paying tax on it at their income tax rate. Higher-rate payers can earn £500. Additional-rate payers get no allowance. If you have used up your savings allowance, then the earnings on Premium Bonds start to look better.
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The present Premium Bond prize rate (the average return for bond holders) of 4.4 per cent is the equivalent of earning 5.5 per cent in a regular account for a basic rate taxpayer who had enough savings to be taxed on their interest. This jumps to the equivalent of 7.33 per cent for a higher-rate taxpayer and 8 per cent for additional-rate payers.
However, you can also get tax-free returns with an Isa — the top easy-access cash Isas pay 5 per cent or more. Bear in mind that the rates are variable so are likely to fall, especially given forecasts that the Bank of England will cut its base rate again in the coming months. You can save up to £20,000 in a tax year into Isa accounts.
Premium Bonds also offer the chance to win large sums. While the odds of winning £1 million are extremely slim, they offer a level of excitement that traditional savings accounts simply do not provide.
The primary drawback of Premium Bonds is that while there’s a possibility of winning one or more prizes each month, the reality for some holders is that they may see very modest or even zero returns.
The present prize rate is lower than the guaranteed rates on many easy-access accounts — and remember it’s the average paid out across all premium bond holders. NS&I’s Electronic Random Number Indicator Equipment (Ernie) randomly distributes the prizes each month, so they are not split evenly. Because two people win £1 million and hundreds more get £10,000 or more, millions are winning nothing to give an average of 4.4 per cent.
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When interest rates are low across the board, not winning is less painful because you are not missing out on lucrative interest rates elsewhere, but right now there are some good returns out there so the cost of holding Premium Bonds is higher.
You need to do the maths. Someone with a balance of £50,000 could miss out on £2,600 in a year before tax from the best savings rate of 5.2 per cent.
That being said, with the sizeable holding that you have in Premium Bonds you would be highly unlucky to win no prizes at all. Ultimately, the decision comes down to how much tax you pay and how lucky you feel.
Anna Bowes has worked in financial services for more than 30 years and helped to set up Savings Champion in 2011