24/05/17Is is time to abandon Premium Bonds?

Premium Bonds have been so popular over the past 61 years, that nearly one in three of the UK population hold them.

What’s not to love? Combining a secure way of saving money with the chance of becoming a millionaire, Premium Bonds have captured the nation’s hearts and seemingly, a large portion of its spare money. From the 1st of May, returns were lowered from 1.25% to 1.15%, which begs the question; are Premium Bonds still an effective way to save, or will you be a bigger winner by putting your money away elsewhere?

It is estimated that around 22 million people hold Premium Bonds, which is a significant chunk of the UK population, currently predicted to be around 65.5 million. National Savings & Investments (NS&I) who issue the bonds, state that around £68 billion is currently held in total.

So what exactly are Premium Bonds and how do they work?

Premium Bonds are lottery bonds that were introduced in 1956 by Prime Minister Harold Macmillan. Originally designed as a way to control inflation and encourage people to save money, they essentially work as a savings account that allows you to deposit money by buying a bond and withdraw it at your discretion.

Each bond costs £1, with a minimum purchase amount of £100. The maximum amount of bonds that can be held at any one time is £50,000. Anybody can buy them, providing they are over the age of 16, and parents, grandparents and great-grandparents can buy them on behalf of children.

The way that Premium Bonds differ from traditional savings accounts comes with the prize structure in place of an interest rate. Each £1 bond is assigned a number, and a robot called Ernie (Electronic Random Number Indicator Equipment) generates winning numbers each month, earning the holders of those bonds a tax-free cash prize.

What can I win?

Two tax-free prizes of £1 million are awarded each month, along with a number of others, ranging from £100,000 all the way down to £25.

As more Premium Bonds are sold, your chance of winning the £1 million prize reduces, which is already tiny as it is. For example, the official odds of a single bond winning the £1 million prize are 1 in 34.3 billion. Without context, this doesn’t mean much, so to compare it against something tangible, the odds of being struck by lightning twice are around 1 in 9 million.

A common problem that NS&I encounters with Premium Bonds is prizes going unclaimed. There are currently around £44 million in unclaimed prizes, some of which date back to 1957. Anybody who wants to check the status of their bonds can enter their holder number at the NS&I website here.

What is the rate of return and how does it work?

As a result of low interest rates set by the Bank of England, the official Premium Bond return is now 1.15%, which means statistically, for every £100 paid in, £1.15 a year is paid out. This is well below the rate of inflation which currently stands at 2.7%.

Probability can be a cruel beast when it comes to money, as it is perfectly possible for one person who holds just £100 in bonds to win the £1 million prize twice in a row, and one person who holds £50,000 in bonds to win nothing at all over the course of five years. Not very likely, but still possible.

Who are Premium Bonds right for?

  • Higher-rate taxpayers who have already used their Personal Savings Allowance (PSA)
  • Anybody who requires instant access to their money
  • Anybody looking to take a punt at winning some money

As Premium Bonds are an NS&I product, they are backed by the Treasury, which makes them an incredibly secure place to put your money.

One of the major draws for buying Premium Bonds comes from the fact that the return is called a prize. Some of us are more prone to high risks and rewards, and the thought of winning £1 million trumps the possibility of not earning any interest from your savings. If you can’t shake off the idea of becoming a millionaire, then buying bonds is definitely less wasteful than playing the lottery each week.

Premium Bonds are not the most efficient place to put your savings if you want to guarantee a return of some kind. To make the most informed choice, savers need to compare:

  • The rate of return for Premium Bonds
  • The rate of return for an ISA
  • The net return after tax of a savings account

Who are Premium Bonds wrong for?

  • Anybody who wants a guaranteed or known rate of return
  • Anybody who wants a return that beats inflation

Inflation as measured by the Consumer Price Index (CPI) is currently 2.7%, which means that any savings or investments that return a lower rate than this will result in a real terms loss. Your annual statement may show more money than you put in, but that money will have reduced buying power.

There are many alternatives to Premium Bonds that offer a variety of returns, such as:

  • Stocks & Shares ISAs: For those comfortable with a certain level of volatility, investing can be lucrative. Of course, there is no guarantee and you may end up with less than you invested
  • Regular savings accounts: With the PSA to protect you from taxation up to a certain point, there are many savings accounts out there that boast competitive rates of return
  • High interest current accounts: There are often minimum income stipulations to these, but if you are applicable then you could enjoy high interest rates for simply switching banks
  • Peer-to-peer (P2P) Lending: This is a fairly new development within consumer investing, but Innovative Finance ISAs can offer substantial rewards for those willing to take the risk

Premium Bonds have become something of a rite of passage, with children and grandchildren receiving them as gifts to encourage saving. It may be a hard habit to shake for some, and Premium Bonds are certainly secure, but for those that would like to see their money stretch as far as it will possibly go, there are far better options available.