Why it is time to dump Premium Bonds
With a drop in the annual prize rate, Martin Lewis weighs up whether you should enjoy the gamble or look elsewhere
Dear Middle Britain,
I know this will hurt, but I can’t keep watching you being treated this way. It’s time to end your love affair with premium bonds. This once beautiful relationship – a way to save tax-free and support the country’s finances in 100pc safety – now needs an intervention. Tomorrow the rate will be cut, and that isn’t the only issue. Many of the 21 million people with more than £60 billion saved should cash in. Maybe, just maybe, you could win millions – but it’s time to weigh up your chances.
What it gives back is dropping to a paltry 1.25pc – or less
Premium bonds are a savings account where the interest is based on a monthly prize draw and the annual prize rate is dropping from 1.35pc to 1.25pc. Yet this is just a vague watermark. It describes the mean average return, indicating that for every £100 paid in to bonds, on average £1.25 a year is paid out. In practice, that’s impossible. The smallest prize is £25, so in practice, if 20 people each had £100 in, for one to win £25-plus, the other 19 must win nowt.
Even if you line up everyone with £1,000 of premium bonds in order of their year’s winnings, the person halfway along would have won… not a penny! In fact, you’d need to walk past nearly two thirds of the line until you hit the first £25 winner. Those who can dredge up school maths will recall this “halfway along” measure is the median average and it’s the best indication of winnings for someone with average luck. For everyone who wins large, many need to win nothing. So the median average is always less than the mean – though they converge, the more bonds you have.
They offer tax-free returns, but that’s no longer special
Premium bond prizes have always been tax-free – which was once a big boon. Yet on April 6 the new personal savings allowance (PSA) was launched, so now all savings interest is automatically tax-free. The only people who now pay tax on savings are basic-rate taxpayers earning more than £1,000 interest a year; higher-rate taxpayers earning more than £500; and all top-rate taxpayers. In practice, 95pc of people no longer pay tax on savings, so for them the tax advantage has gone. For those who do still pay savings tax, premium bonds retain appeal. As prizes don’t count towards the PSA, it’s effectively an extra tax-free allowance.
It promised a safe haven, but...
Premium bonds are operated by NS&I, which is Treasury-owned, so your capital is as safe as it gets. Only the “interest” is a gamble. But these days all UK regulated savings accounts are protected up to £75,000 per person, per institution, by the Financial Services Compensation Scheme, so the safety boon isn’t as big.
Don’t be seduced by ‘the win’
I can’t deny it, premium bonds do have a certain frisson. The sense of the tombola can override logic, with joyous declarations such as “I win £25 every few months – it’s fantastic!”
But with £10,000 saved at 1.25pc, they might win £100+ a year, while the same money in the top savings account “wins” £300 a year guaranteed. Normally, if you take a risk, you expect to earn more. Here, people seem to be happy to earn less to gain a gamble.
So premium bonds are not as good as they used to be, but ultimately it’s only worth re-allocating your cash if there’s something better out there…
Premium bonds v savings: if you don’t earn over the PSA
If all your savings interest is tax-free, then premium bonds’ 1.25pc rate is beaten by the top easy-access savings at 1.45pc and the top cash ISA at 1.3pc ( go to mse.me/topsavings). Of course, if your money is languishing in a poor-paying legacy account, premium bonds win. But then you should be asking: “Should I shift it to premium bonds or a top savings account?”
Premium bonds are even less favourable. With £1,000 saved, you’ve a less than 1 in 3 chance they’ll beat a 1.45pc savings account. Even with £50,000 in, it’s at best 1 in 6.
And far higher interest is possible via bank current accounts – TSB Classic Plus pays 5pc on up to £2,000; Club Lloyds 4pc on £5,000; and Santander 123, pays 3pc on up to £20,000. Max that out and you earn £590 a year: there’s less than a 1 in 40 chance premium bonds will beat that. So unless you’re extremely lucky, premium bonds earn far less than the top savings – and the safest bet is to divorce them.
Premium bonds v savings: if you do earn over the PSA
Premium bonds do have an advantage for higher- (or top-) rate taxpayers who’ve used up their PSA, as “wins” are always tax-free and don’t count towards the allowance. Yet the same is also true of cash ISAs, of which the top easy access deal pays 1.3pc and you can get more if you fix.
After that, to beat premium bonds’ 1.25pc, in taxed savings you’d need to earn a pre-tax rate of 1.6pc as a basic-rate taxpayer, 2.1pc at the higher rate and 2.3pc at the top rate. This is do-able in top bank account savings, but only on limited amounts (a couple can save £60,000 at 3pc in Santander 123, with two single and one joint account allowed), and in long-term fixed savings where you need to lock your money away.
Going beyond just the rate and incorporating the prize distribution, with the full £50,000 in premium bonds, a basic-rate taxpayer has a 40pc chance of beating the top 1.45pc easy-access savings; a higherrate taxpayer a strong 73pc chance. However, compared to Santander 123’s 3pc, on £20,000, even a higherrate taxpayer only has a 1 in 9 chance of bonds winning.
So for higher-rate taxpayers with big savings, premium bonds are a decent bet, if you’ve first filled up high-interest current accounts, cash ISAs and considered locking money away in long-term fixed rates.
Breaking up is hard to do…
Of course, my analysis is based on the statistics of average luck. By definition, some always beat the average, and the dream of winning keeps many entertained – though even with the full £50,000 invested, your chance of winning a million over a year is still just one in 50,000.
If savings give you only a marginal gain over premium bonds, it’s legitimate to value in your thrill and stay engaged. Seeing premium bonds as a frolicking lottery for non-core cash, without risking capital, isn’t a big sin. However, if it’s money you rely on for growth, for all but the biggest savers it’s a poor bet.