Are premium bonds really a good deal?
Premium bonds are one of the most popular savings products in the UK. First launched in 1956 in an attempt by Prime Minister Harold Macmillan to reduce inflation and encourage thrift, the current economic climate couldn't be more suited to them. With inflation standing at 5.0% and savings rates at an all-time low alternative savings vehicles are much sought after.
Could premium bonds be the solution?
With more than 22 million bondholders and almost £41 billion invested up from £4 billion in 1998 it's clear that 55 years after their launch they're still hugely appealing to the general public.
But should they be?
Premium bonds are an investment where, instead of interest payments, investors have the chance to win tax-free prizes. When someone invests in premium bonds they are allocated a series of numbers, one for each £1 invested. The minimum purchase is £100 (or £50 when you buy via monthly standing order), which provides 100 bond numbers and, therefore, 100 chances of winning a prize. You can hold up to £30,000.
Anyone aged 16 or over can invest in premium bonds but they can also be bought for a child under 16 by their parent, guardian, grandparents or great-grandparents. They cannot be held jointly or transferred to another person. National Savings & Investments, the provider of premium bonds, claims they are a fun yet serious way of saving.
But fun aside, what are the benefits? Anna Timms, director of IFA firm Investment Sense, says: One of the most important benefits for those who buy premium bonds is the fact that capital is 100% guaranteed. But the fact that premium bonds are protected is hardly a selling point given the government now protects up to £85,000 per savings account per institution anyway.
Find out how much you could win with the premium bonds calculator from Moneysavingexpert.com
The big prizes
Of course, the big draw for premium bonds is the possibility of winning big sums of money. Each month, prizes of between £25 and £1 million are given out following the draw. One lucky bondholder scoops the jackpot, while over 1.5 million £25 prizes are awarded.
There are also four £100,000 prizes, 42 £10,000 prizes, 1,051 £1,000 prizes and almost 31,000 £100 prizes. But what counts here are the odds. With £1,000 worth of bonds, you only stand a one-in-42.06 million chance of winning the top prize. You're far more likely to be struck by lightning.
But the slim chances of winning big isn't the only drawback of premium bonds. The major downside is that your savings don't earn any interest. Instead, the interest accrued funds the monthly draw.
While the prizes are tax-free and there is always the chance of winning the jackpot, the indicative average interest rate, of 1.5%, is currently significantly lower than inflation, says Timms. This means that if you were to receive the average amount of prize money the value of your savings would actually fall in real terms.
Long-term bondholders thinking they've got more chance of a prize because they're due a win will also be disappointed. There is no guarantee that you will win anything, even if you have the maximum £30,000 holding.
This is because each month the prize winners are selected totally at random by ERNIE (Electronic Random Number Indicator Equipment) and whether you've held your premium bonds for six months or 20 years, you have the same chance of being selected, says Andrew Hagger, spokesperson for price comparison website, moneynet.co.uk.
Odds are stacked against you
The odds of you winning the jackpot payout are very slim, so you could have £30,000 of bonds that earn you nothing in 12 months, whereas if you'd put it in a best buy one-year fixed-rate bond from Sainsbury's Finance at 3.2% AER, for example, you would have a definite return of £768 after basic-rate tax. That's the equivalent of more than 30 £25 winning cheques.
This is the crux of the argument against premium bonds. Even as saving rates have fallen to record lows there is still the opportunity to earn some interest if you opt for a competitive account.
"With average luck, premium bonds of £5,000 would expect to win £50 a year," says Kevin Mountford, head of banking at moneysupermarket.com. "This compares poorly with savings rates where you would only need a rate of 1% to match this." However, Timms argues: "Traditional deposit accounts don't offer the chance to win a £1,000,000 jackpot, despite the hugely long odds. This is what attracts many to premium bonds; the fun rather than the economic return."
For those who do choose to take out premium bonds, some are likely to benefit more than others, namely higher-rate taxpayers.
In a conventional savings account higher-rate taxpayers pay more tax on their savings. Once they've used up their tax-free ISA allowance, they could consider using premium bonds to avoid paying any tax.
But this is really only beneficial if they have a lot of money to put away and even then getting a decent return is not a dead-cert. In fact, even with £30,000 in premium bonds savers still only have a one-in-five chance of getting the same return as they would from a savings account.
Basic-rate taxpayers should try looking at what other options are around in terms of savings accounts and ISAs.
Carolyn Monchouguy, spokesperson for NS&I, says: "If you have won a prize we will automatically send or pay it to you.
"Sometimes we find prizes go unclaimed as people have changed addresses and not informed us."
If you're worried that you might have lost out on a prize, to claim one you can phone NS&I on 0500 007 007 or write to it at National Savings & Investments, Glasgow G58 1SB.
Customers can also use the mylostaccount.org.uk website to search for any lost Premium Bonds. There is no time limit for claiming prizes.
Monchouguy adds: "Following the death of a bondholder, the value of the bonds will form part of the deceased's estate."
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
A form of National Savings Certificate, premium bonds are effectively gilt-edged securities: you loan your money to the government and, in return, it pays you for the privilege with a guarantee it will return your capital at a specified date. Where premium bonds differ is that the interest payments (currently 1.5%) are pooled and paid out as prize money and you can get your cash back within a fortnight, with no risk. Launched by Chancellor of the Exchequer Harold Macmillan in his 1956 Budget, every single £1 unit has the same chance of winning and in May 2011, 1,772,482 winners (from a total draw of 42,539,589,993 eligible bond numbers) shared £53,174,500. The odds of winning are 24,000 to 1 and the maximum holding is £30,000 per person but it remains the only punt in which you can perpetually recycle your stake money.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
Where APR is the rate charged for money borrowed, Annual equivalent rate is how interest is calculated on money saved. The AER takes into account the frequency the product pays interest and how that interest compounds. So, if two savings products pay the same rate of interest but one pays interest more frequently, that account compounds the interest more frequently and will have a higher AER.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.