How premium bonds can play a role in financial planning

Premium bonds are a British institution. But you may not realise they can play a role in financial planning as a tax-efficient way to hold cash.

Launched by the UK Government in 1956, premium bonds are today issued by the government’s National Savings and Investments (NS&I) agency. NS&I has more than 24 million customers, and more than 21 million of these hold premium bonds (1).

Britons can deposit between £25 and £50,000 in premium bonds. Each £1 bond is entered into a prize draw, with a chance to win prizes that range from as little as £25 to as much as £1 million. The draw is held once a month and, crucially, any prizes are completely exempt from income tax. And if you have the good fortune to win a big prize, it won’t be subject to capital gains tax either.

As with raffle tickets, the more bonds you buy, the higher your chances of winning. And the odds of winning a prize are 21,000 to 1 for every £1 bond in any given month.

Analysis of 50 premium bond draws stretching back to May 2020 found the average holding of a typical £1 million winner was £38,779. There are two £1 million prizes a month and average premium bond holdings stand at £5,250 (2). But there was a £1 million winner in August 2001 who held just £1,001. The research also found nearly half (47 percent) of those winning £100,000 during the 50 draws held the maximum allowance of £50,000.

A tax-efficient way to hold cash

While the chances of a big win can be a real attraction, premium bonds can have a practical role in financial planning, perhaps as a tax-efficient alternative to a savings account. Crucially, there is no risk to the initial amount you deposit. So holding premium bonds is not like gambling.

Then again, they are not like bank accounts either. With a bank savings account, guaranteed interest is accrued on a regular basis, but premium bonds pay no interest. Instead, the monthly winning totals are derived from the annual prize fund, which pays for the monthly draws. This prize fund rate fluctuates with economic conditions and changes to the Bank of England’s base interest rate.

As at 13 June 2024, the annual prize fund rate on offer from premium bonds stood at 4.4 percent (3). This was roughly in line with some of the higher rates available from instant access savings accounts.

Higher and additional rate taxpayers can particularly benefit from premium bonds’ tax-efficient role as an alternative to holding cash. After all, interest on savings accounts will be taxed unless it’s earned within a tax-efficient structure such as an Individual Savings Account (ISA). That said, basic rate taxpayers have a personal allowance on interest of £1,000 a year, while for higher rate taxpayers the annual allowance is £500. There’s no such allowance for additional rate taxpayers.

So premium bonds can offer a tax-efficient alternative to cash deposit savings accounts, in which consumers may need access to capital at short notice, perhaps for rainy day needs. You can cash in your premium bonds at any time and it takes up to three banking days for the money to reach your bank account.

Premium bonds also hold no depositor risk because they’re government backed. This means that, as long as the UK government remains solvent, deposits are automatically fully protected.

How payouts are made

Buying premium bonds is straightforward: they can be purchased online, by phone and post. All UK citizens are eligible to buy them and it’s possible to save on behalf of younger family members below the age of 16, with the same £50,000 limit for each child.

One you’ve deposited your money, you can use the Prize Checker function on the NS&I app to check if you’ve been awarded a prize in the latest monthly draw. You can also stay logged in through digital devices such as Amazon’s Alexa, and check using the Alexa Skill function.

If at any time you forget to check for winnings, the NS&I app also keeps a record of the previous six draws and will flag if you’ve failed to claim any older prizes prior to this.

When you do win, smaller prizes of up to £5,000 are paid directly into your nominated bank account and premium bond holders can opt for notifications by email or text message. Prize money is paid into accounts by the seventh working day of each month and winners can opt to reinvest by buying additional premium bonds, up to the £50,000 limit.

For prizes of more than £5,000, NS&I may request completion of a claim form so they can process your winner’s payment. Once received, these winnings are paid as you instruct. Those who win the £1 million jackpot are visited by an official NS&I representative.

While premium bonds can be a tax-efficient way to hold cash, you can receive interest rates on instant access cash ISAs that match the premium bond annual prize fund rate (4). So a cash ISA may be a more appropriate approach for some of us, although you can only put a maximum £20,000 a year into cash ISAs. Moreover, many of us may instead prefer to use our annual ISA allowance to invest in non-cash assets such as equities (shares) and bonds.

To sum up, premium bonds can play a role in financial planning and an adviser can help you decide if it might be right for you to hold them. At Schroders Personal Wealth, one of our key principles is to have regular reviews with an adviser, to help you make the best use of your tax allowances.

Sources:

(1) National Savings & Investments (NS&I, www.nsandi.com), 13 June 2024.

(2) This is Money (www.thisismoney.co.uk), ‘How much you need in premium bonds to win the £1m jackpot? (It’s less than you might think)’, 8 June 2024.

(3) National Savings & Investments (NS&I, www.nsandi.com), ‘Interest rates’, 13 June 2024.

(4) Moneyfacts (moneyfactscompare.co.uk), ‘Best easy access Cash ISAs’, 12 June 2024.