Premium Bonds are a type of investment product which offers a prize draw. Each month, 22m people (currently participating) have the chance to win up to £1m, tax-free. Yet there is also a high chance of winning nothing at all; or, only a small amount. Recently, the issuer National Savings and Investment (NS&I, the issuer) has increased the odds of winning a prize, so the “rate” in October 2022 currently beats most top easy-access accounts – according to headlines.
Given this change, how do Premium Bonds compare to other assets, particularly cash? Below, our Tees Valley financial planners at Vesta Wealth offer some thoughts on the attractiveness of Premium Bonds in 2022 and where they might sit in a financial plan in light of other key developments (such as rising interest rates).
How Premium Bonds work
Each person can save up to £50,000 total in Premium Bonds. Rather than generating interest like cash savings however, a prize draw is on offer instead – with the odds of winning rising with each £1 you hold in bonds. You must be at least 16 years old to buy Premium Bonds and you can buy them for yourself, for a child, grandchild or great-grandchild. Each month, two £1m prizes can be won and there is currently a 23,957 to 1 chance of winning the smallest prize of £25.
National Savings & Investments (NS&I) can change the prize rate, thus lowering or boosting the size of the total prize pot. In October, the prize rate increased from 1.4% to 2.2% (the biggest increase since 1980), adding £76m to the pot and 97,752 more prizes. This has drawn media attention since many regular savings accounts are presently offering rates below 2.2%,
Are Premium Bonds now “worth it”?
First of all, it is important to stress that the odds of winning any prize at all from Premium Bonds are still very low. One study shows that there are 119,335,128,719 prizes worth £0 each month (so “winning” £0 on most bonds is a near-certainty). Yet the chances, per bond, of winning even £100 is just 1 in 159,110. Those with “average luck”, therefore, may not reach the 2.2% “rate” currently promoted by NS&I and some investors may prefer a guaranteed interest rate from a savings account. However, this is not to say that Premium Bonds are useless.
One other key development this year has been the steady rise in UK interest rates. This has led banks to start raising their own rates on cash savings accounts. Whilst this is certainly welcome, there is also a risk that many savers inadvertently end up paying tax on the interest generated from cash savings. This is because each person can typically earn up to £1,000 interest without tax under their Personal Savings Allowance (£500 for a Higher Rate taxpayer), yet any interest earned over this threshold is taxed at the person’s highest income tax rate. With interest rates now going up, more savers could unwittingly breach their Personal Savings Allowance (PSA).
For those at risk, Premium Bonds could be a good alternative to cash savings where the interest earned could breach their tax-free threshold. This is because Premium Bonds do not generate interest but rather offer a prize draw (so the “returns” cannot count towards your PSA). Premium bonds can be accessed at any time without penalty and being backed by the UK government all savings held with NS&I are guaranteed.
However, with both cash and Premium Bonds, it is important to consider whether your money might be put to better use elsewhere. Whilst cash savings can now offer up to 4.75% fixed, this is still lower than the 10.1% current rate of CPI inflation (meaning this could still result in a “real terms” loss of 5.35%). With Premium Bonds, there is a very small chance of winning a prize that beats 10.1% on your money, but the odds are astronomical. As such, those looking to build their long-term wealth will likely do better to consider other asset classes – such as shares. Whilst the short-term risk and volatility are higher, the long-term growth prospects can be higher when you craft an appropriate investment strategy with a financial planner.
As a general rule, cash is useful as an “emergency fund” (e.g. 3-6 months’ worth of living costs). If the total saved for this puts you at risk of exceeding your PSA, then you could consider putting some of it into a cash ISA (where interest can be earned tax-free) or Premium Bonds. Yet to be sure of what you should do in your own case, speak to a professional about your goals, current financial position and attitude to investment risk. The discussion(s) will help bring clarity about how cash and/or Premium Bonds should feature in your financial plan.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
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t: 01228 210 137
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This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.