Premium bonds: what you need to know
How do they work?
Issued by government-run National Savings & Investments (NS&I), premium bonds are unique in that they do not pay interest and never reach maturity. Instead, each £1 bond has a small chance each month of winning a tax-free prize, varying from £25 to £1 million, if its number is selected.
Neither the bonds themselves nor the prizes ever expire. In theory you could still win prizes with bonds you purchased in 1956 when the scheme began. In February 2014, NS&I was holding 980,000 unclaimed premium bond prizes worth more than £46 million.
How much can I invest?
You can invest up to £40,000 in premium bonds. This is set to rise to £50,000 in spring 2015. In addition, on 1 August 2014 a second monthly £1 million jackpot was be introduced.
NS&I estimates that in February 2014 it paid out more than £50 million, divided across 1.8 million prizes. Although 90% of customers hold fewer than £5,000 worth of bonds, these only make up about 9% of all eligible bonds. Only 2.3% of customers hold at least £30,000 of bonds, but this represents 36% of all eligible bonds.
Because prizes are tax-free, you get to keep all of your winnings. NS&I also offers the option to reinvest winnings in more bonds.
What size return will I get?
On average, premium bonds pay out an investment return equivalent to about 1.3%. In theory this means you would win just over a penny a year for each pound of bonds owned. But because of the randomness of the process, you may win less – or you may win a great deal more.
Where does the prize money come from?
The prize money is not funded by the sale of new bonds. Instead, the money represents the amount that would be paid in interest if premium bonds were regular government bonds. The prize fund interest rate, prize values and odds of winning are all subject to change. Each bond has around a 1-in-26,000 chance of winning a prize.
Who is Ernie and are the numbers really random?
There are debates in computing and mathematics circles over whether a truly random number is really possible, given that the numbers produced by a computer are by definition the result of a set process. However, in terms of unpredictability, Ernie (Electronic Random Number Indicator Equipment), the computer producing winning numbers, puts on a pretty good show. The current version of Ernie takes two and a half hours to produce each number.
Ernie receives Christmas and Valentine's Day cards every year, probably from hopeful bondholders. However, NS&I maintains that he is a cold-hearted machine and cannot be swayed by such flattery.
Where can I buy them?
You can apply to buy premium bonds at your local post office or over the phone, online or by post. Once you own some you can buy more via direct debit.
This feature was written for our sister publication Money Observer
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.