(article updated 16th June 2011)
Money tip #57 –
In his Budget of 17 April 1956, Harold Macmillan announced that Premium Bonds were to be launched to reduce inflation and to encourage thrift among those who were attracted not by earning interest but by winning prizes. Since then the economic and investment landscape has changed. So are they still a valid form of investment? I answer that question by looking at the good, the bad and the ugly side of premium bonds:
- Easy to understand
- Tax-free returns which is particularly beneficial for high rate income tax payers.
- Every premium bond, which costs only £1, are entered into a monthly prize draw.
- You could become a millionaire (although there is only 1 such prize a month).
- You can withdraw the money at any time (although there will be an inevitable admin delay).
- Can be bought on behalf of children (under 16’s) by parents and grand-parents.
- Your capital is 100% protected- but you can only hold £30,000 per person. Having said this, under the Financial Services Compensation Scheme (FSCS) a bank account is 100% protected up to £85,000 – so the risk free aspect of premium bonds is no longer a selling point in my view.
- 1.5% interest – slightly misleading as you don’t get interest on premium bonds. Instead the total prize fund is calculated as 1.5% of the value of the bonds in existence. This is then split amongst the various sized prizes which are up for grabs each month. So the only way to actually get a guaranteed 1.5% return on your money is to own every premium bond in existence (which would cost you £26 billion if it were allowable) otherwise the chances are your return will be a lot less than 1.5% – unless of course you are lucky.
- 1.5% is less than you could earn in a savings account - But admittedly that is equivalent to a gross savings rate of 3% for a 50% income tax payer which is not terrible. But if you are looking for safe tax free returns then National Savings Certificates would be a better option (see my post Money tip #30 – One way to protect your savings from inflation, both tax and risk free).
- Inflation - Unless you win, inflation will erode the value of your premium bonds (inflation is currently in excess of 4%).
- Your chances of winning the million pound prize are over 26 billion to one!!. This means that you are 1,857 times more likely to scoop the jackpot on the national lottery. The odds would only be the same if you invested £1,857 into premium bonds. So don’t count on becoming rich.
So are they worth it?
I don’t think you can seriously class premium bonds as investments – they are basically a risk free flutter with an almost zero chance of winning. The only people for whom I can see premium bonds being of interest are:
- People paying 40% or 50% income tax - Given the poor rates in most savings accounts in the long run premium bonds could offer a tax/risk free return (and 1.5% return equates to 3% gross from a standard savings account for Mr ‘’50% income tax’’). But you would be better off exhausting all other avenues first such as ISAs, NS&I certificates etc. And let’s be honest if you can afford to put £30,000 into premium bonds you are unlikely to be hanging on to the dream of winning a million pounds.
- Granny (or similar relative) wanting to give something to a grandchild (child) - While over time it is likely that the value of the initial investment will be eroded by inflation there is a chance that the gift could make the recipient a millionaire. But there are other investments for children which should be considered as well, such as Child Trust Funds which can earn interest tax-free.
But for most people, given the chances of winning, if they wanted a risk free flutter they would be better off putting the aforementioned £1,857 into a savings account and use the monthly interest to buy lottery tickets. For a basic rate tax payer, in order to generate £1 a month net interest to buy a lottery ticket (premium bonds draws are monthly) they’d only need to get a gross savings rate of 0.8%pa! So given that standard savings account rates are nearer 3% gross at the moment, in reality they’d have enough interest to enter weekly lottery draws.
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