Offering a secure and tax-free haven for depositing funds, premium bonds have been popular with savers for decades, but with a reduction in the odds of winning from the December draw onwards, we take a look at whether they are still a good savings option for savers.
Premium bonds are managed by National Savings & Investments (NS&I) and enable savers to buy bonds that are automatically put into a monthly prize draw. The bonds have long been popular with savers as they are Government-backed, so the money invested is secure, and the money held, along with any prize money, is tax-free. A maximum of £50,000 is allowed to be held in premium bonds.
Back in September, NS&I announced that, due to reaching maximum funding levels, it was cutting the annual prize fund rate from 1.40% to 1.00%, which came into effect with the December draw. At the same time, the odds of winning fell from 24,500 to 1, to 34,500 to 1.
In an effort an understand the value for money premium bonds represent, many try to equate the 1.00% annual prize fund rate to a savings rate. With a savings account, if it offers a rate of 1.00% AER, this would mean that for every £100 the saver deposited into the account, they would earn £1 in interest. But premium bonds do not work like this and instead whether the saver earns anything on the money deposited into the bond depends solely on luck. For example, a saver could deposit £100 into the bond, but they could receive nothing in return, or they could win the £1 million jackpot.
The 1.00% annual prize fund rate actually refers to the percentage of the money held within premium bonds that is allocated to the prize draw. So, a rate of 1.00% means that 1.00% of all the money currently being held within premium bonds is being paid out in prize money. For the December 2020 draw, this was 1.00% from a total of over £98 billion held within premium bonds.
Prior to the rate cut, the annual prize fund rate was 1.40%, which meant that 1.40% of all money deposited into premium bonds was paid out in prizes each month. Although it would seem that prior to the rate cut premium bonds were awarding more money in prize draws, this may not be the case if the total amount of money in premium bonds was significantly less than the total amount held after the rate cut. For example, if the total amount held was £100, 1% of this would be £1, but if the total amount was £50 (an overall lower amount) at a rate of 1.40% (a higher rate), the amount received would be £0.70.
Saying this, despite the amount of money in premium bonds increasing significantly during 2020, from just over £85 billion held in premium bonds in January to over £98 billion in December, the cut in rate from 1.40% to 1% has resulted in a lower amount being paid out to premium bond winners.
Although there are premium bond calculators available that try to determine an individual’s likelihood of winning on the amount of money they have invested, these calculators are just rough estimates that determine chances of winning based on averages, and in reality the chance of winning is simply luck. Normally, the more a person deposits into the bonds the higher their chances of winning, but just because someone owns £50,000 worth of premium bonds does not necessarily mean they will win anything while someone with just £100 worth of bonds could scope the £1 million top prize. For example, back in 2004 , a bond-holder with premium bonds worth just £17, which was originally purchased in 1959, won the top £1 million prize. But, those considering premium bonds should remember that a bond holder with a large number of bonds has more opportunities to win, so it is unusual for a holder of a small number of bonds to win large prizes.
So, while we cannot calculate the chances of winning with a premium bond, we can look at the odds of winning.
When the rate on premium bonds was cut to 1%, at the same time the odds fell to 34,500 to 1. This means that every single bond has a 1 in 34,500 chance in winning. Even if other bond holders start withdrawing their money from premium bonds, the odds of any single bond winning will remain the same, instead there will be fewer prizes given out each month.
At the end of the day, no matter how much analysis of statistics and odds of winning, the chances of winning with premium bonds is down to luck.
Those considering a premium bond should always be aware that even owning the maximum amount of £50,000 in premium bonds is no guarantee of winning. And, as there is no guarantee of winning, savers depositing money into a premium bond should be aware that inflation could erode the value of the money held within premium bonds.
What makes premium bonds attractive to savers is that they offer a tax-free and secure option for depositing money. As a result, a premium bond is probably not a good choice for those looking to build a savings fund or who want to ensure that they earn interest on the money they deposit into a savings account, but could be a good option for those who have used up their tax-free savings allowance.
For those looking to build their savings, but who still want access to their funds, an easy access savings account could be a better option. Savers concerned about tax can consider an easy access ISA, which allows up to £20,000 to be deposited tax-free for the 2020/21 tax year. Those who already have some savings and who are happy to lock their money away should look at the fixed rate bond and fixed rate ISA charts . Both fixed rate bonds and ISAs usually pay higher rates than easy access accounts and ISAs but, in return, savers have to lock their money into the accounts for a predetermined length of time, usually between one and five years.
While premium bonds do offer the security of being Government-backed, savings accounts under a bank or building society with a UK banking licence are protected under the Financial Services Compensation Scheme (FSCS). Under this scheme, funds of up to £85,000 deposited with a bank or building society under one banking licence, are protected in the event of the bank or building society collapsing. More information about the FSCS can be found on our depositor protection schemes page.
As well as this, savers worried about paying tax on their savings but who have more than £20,000 to invest or who do not want to open an ISA, should be aware that under the Personal Savings Allowance (PSA), basic rate taxpayers can earn up to £1,000 in savings interest tax-free.
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