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Should you ditch Premium Bonds for a Cash ISA?

We take a look at your chances of winning with premium bonds and whether there’s a better way to save.

Important information - This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Premium bonds are the country’s biggest savings product, with an incredible 22 million people holding £121bn worth of them.

We’re drawn to them by the irresistible allure of the chance they could make us millionaires overnight – without having to pay a penny in tax.

However, although they’re a national treasure, they still have their flaws.

This article isn’t personal advice. If you’re not sure if something is right for you, seek advice. Tax rules change and benefits depend on individual circumstances.

Investing in premium bonds – what you need to consider

The biggest attraction of premium bonds over any other kind of savings is the chance to win a major prize.

Every bond is entered into a prize draw every month – in May, there were five million prizes – including over 1,000 paying £10,000 or more – and two of £1 million.

Clearly if you win big, no other savings product could come anywhere near being as rewarding.

However, in order to win big, you have to defy some pretty hefty odds.

Your chances of winning a million are, for example, around 60 billion to one per £1 bond. Even if you hold £1,000 of bonds, your odds only fall to around five million to one.

It's also important to be aware that in order to fund the prizes, premium bonds pay no interest. On the face of it, the current prize rate looks like someone with average luck could expect a return of 3.3%, which compares favourably to other savings products.

However, this overlooks the fact that the minimum prize is £25, so the way those prices are distributed is very lumpy. It means the average person with £1,000 in bonds with average luck won’t actually win anything at all in a year.

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Luck versus inflation

Not winning anything all year means the money in premium bonds is likely to be constantly eroded by inflation. The more you hold in them, and the longer you have them for, the more spending power you lose.

If, for example, you had them for the past 10 years, total inflation has been almost 48% over that period – which blows a huge hole in the spending power of your savings.

It’s why some people prefer to use it for cash they’ll need in the relatively near future – like money put aside to pay their self-assessment tax bill.

Remember, as part of your savings portfolio, you’ll need to make sure you have a rainy-day savings pot for any emergencies – that’s around three to six months’ worth of essential expenses if you’re working, or one to three years if you’re retired.

A better way to save? (that doesn’t rely on luck)

For money you want to keep in cash for up to five years, it could be worth thinking about a Cash ISA.

Easy access ISAs pay a variable rate, and at the moment, the most competitive on the market aren’t keeping up with runaway inflation. However, they’re closing the gap more effectively than a premium bond holder with average luck.

And given that inflation is expected to be around 5% by the end of the year, it makes the rates on offer look more interesting.

Another major draw for any NS&I product is that your money is 100% guaranteed by the Treasury. For most savers though, this doesn’t make a huge practical difference. That’s because the Financial Services Compensation Scheme covers the first £85,000 held with each institution – assuming you bank in the UK – which is enough to cover most savings balances.

For those with really big balances, the NS&I guarantee is more attractive, because you don’t have to hold multiple accounts to make sure you stay below the £85,000 limit.

But for these savers, premium bonds are less of a draw than other NS&I products, because you can only hold up to £50,000 in them, so you’ll still end up managing more than one account.

Instead, these savers might prefer a cash savings platform, where they can split their cash between a number of institutions in order to stay under the £85,000 threshold with each – and manage them all in one place.

They might then want to take advantage of Cash ISAs on these platforms too. Remember though, you can only add in up to £20,000 every tax year which would use your full ISA allowance.

So, what should savers do?

There will be plenty of people who take all this into consideration, and still decide to opt for premium bonds – it’s hard to completely ignore the chance to win a big prize, however vanishingly small that chance might be.

For others, the fact a Cash ISA offers a more reliable return than premium bonds will tip the balance in their favour.

When you’re weighing them up, there’s no ‘right’ answer – there’s just the one that’s right for you.

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Written by
Sarah Coles
Sarah Coles
Head of Personal Finance

Sarah provides insight and analysis to the media on topics such as savings and financial planning, and co-presents HL's ‘Switch Your Money On' podcast.

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Article history
Published: 20th December 2023