A premium bond is a type of savings account offered by National Savings and Investments (NS&I) in the United Kingdom. When you buy premium bonds, you are entered into a monthly prize draw where you can win tax-free prizes between £25 and £1 million.
How do premium bonds work?
With premium bonds, you do not earn any interest on your investment. Instead, NS&I takes your money and invests it in government bonds. The interest they earn is used to fund the monthly prize draws.
For every £1 you invest, you are allocated a unique bond number which is entered into the monthly draw. The more bonds you hold, the higher your chances of winning a prize. The odds of any £1 bond winning a prize is 24,500 to 1.
The prizes are tax-free under current UK tax rules. This makes them an attractive savings option for those who want to earn returns on their money without paying income tax or capital gains tax on any winnings.
What are the prize draw odds?
The prize structure for premium bonds is as follows:
| Prize value | Odds of winning (per £1 bond) |
|---|---|
| £1 million | 1 in 24,500,000 |
| £100,000 | 1 in 2,450,000 |
| £50,000 | 1 in 1,225,000 |
| £25,000 | 1 in 490,000 |
| £10,000 | 1 in 245,000 |
| £5,000 | 1 in 123,500 |
| £1,000 | 1 in 24,500 |
| £500 | 1 in 12,250 |
| £100 | 1 in 12,250 |
| £50 | 1 in 24,500 |
| £25 | 1 in 49,000 |
So while your odds of winning a small prize are decent, your chances of landing a £1 million jackpot are extremely slim at just 1 in 24.5 million. The larger prizes help advertise premium bonds, even though very few people actually win them.
How are premium bond prizes paid out?
If any of your bond numbers are selected in the monthly prize draws, NS&I will contact you to let you know you have won. You can choose to have your winnings:
- Paid directly into your bank account
- Reinvested into more premium bonds
- Paid to you by cheque
Smaller prizes under £5,000 are usually paid out automatically into your nominated bank account. With larger prizes, you need to make a claim to NS&I to collect your winnings.
What are the investment limits?
You can hold between £25 and £50,000 worth of premium bonds. The minimum investment is £25 for a single bond number. The maximum limit per person or child under 16 is £50,000.
You can buy premium bonds as gifts for other people, but the £50,000 limit applies to the recipient not the buyer. So you cannot use gifts to get around the cap.
Are there any risks?
Premium bonds carry less investment risk than stocks and shares or other assets. This is because your original capital is always secured by the UK government. However, there are some risks to be aware of:
- Your bonds do not earn interest. So your capital can potentially be eroded by inflation over time.
- There is an opportunity cost versus saving in an interest-bearing account.
- Your winnings are not guaranteed. You might win nothing at all.
- The £1 million jackpot has worse odds than the lottery.
While premium bonds do not carry market risk, the value of your investment can still go down in real terms. You also forgo the guaranteed interest paid by other savings accounts.
How are winnings taxed?
One of the big advantages of premium bonds is that all prizes are tax-free under current UK law. NS&I does not deduct any tax before paying out your winnings.
This means premium bond holders do not have to pay:
- Income tax on prize money
- Capital gains tax on any investment growth
You do not even need to declare interest earned from premium bonds on your UK tax return. This tax-free treatment gives them an edge over most other investments.
When are prizes drawn?
Premium bond prize draws take place each month. The draw schedule is as follows:
| Month | Draw date |
|---|---|
| January | 1st |
| February | 1st |
| March | 1st |
| April | 1st |
| May | 1st |
| June | 1st |
| July | 1st |
| August | 1st |
| September | 1st |
| October | 1st |
| November | 1st |
| December | 1st |
You can buy premium bonds any time. Those purchased before the end of the month still qualify for that month’s draw. Bonds are held for one full calendar month before they become eligible.
So if you bought bonds in January, they would first enter the March prize draw. Winners are notified directly after the draw takes place.
How long can bonds be held for?
One of the advantages of premium bonds is that there is no time limit on how long you can hold them. The bonds remain in the prize draws indefinitely until you cash them in.
So you can treat premium bonds as a very long-term investment if you wish. Some bonds have been held by investors for over 50 years.
However, there is still some advantage to withdrawing your money after a number of years. This is because the real value of your capital can be eroded by inflation over time. But you are not forced to cash out bonds after any set period.
Can I withdraw money early?
Yes, you can withdraw some or all of your premium bond investment at any time. Just log in to your NS&I online account and select the withdrawal option.
Withdrawals are processed on the first day of each month. The money will then be transferred to your nominated bank account within four working days.
Partial withdrawals are allowed, subject to keeping at least £25 invested. When you withdraw money, your remaining bonds stay entered in the prize draws.
Are premium bonds safe?
Premium bonds are considered very safe for several reasons:
- They are backed by the UK government, so your capital is secure.
- The money is held by NS&I, a state-owned savings institution.
- Your investment is covered by the Financial Services Compensation Scheme up to £85,000 per person, like bank savings accounts.
- You get easy access to your original investment at any time.
Premium bonds are therefore seen as a very low-risk savings option. Your capital is protected while also benefiting from tax-free prizes.
Where is the money invested?
NS&I uses the money from premium bonds sales to invest in UK government bonds, known as gilts. These gilts are issued by the Treasury to fund public borrowing.
So in effect, buying premium bonds helps provide funding for essential public services in the UK. The government pays interest on these gilts to NS&I, which helps fund the monthly prizes.
How are prize winners selected?
Premium bond prizes are drawn via a random digital lottery operated by Ernst & Young. It uses two industrial grade random number generating computers to select each month’s winners.
These computers are housed in a secure facility and operated independently of NS&I. Staff from Ernst & Young oversee each draw to ensure it is fair.
After each draw takes place, NS&I receives a list of the bond numbers selected by the computers. These are matched against customer accounts to identify the winners.
Are draws fairly operated?
Yes, the use of random number generating computers means each monthly premium bond draw is completely random. Every bond has an equal chance of being selected.
Having the draws independently run and audited by Ernst & Young ensures there is no tampering or bias towards any bond numbers. The computers cannot differentiate between bond holders.
NS&I states the prize draw system is designed to be mathematically fair based on the odds. There is no way for any person to improve someone’s chances of winning.
Can prizes be inherited?
When a premium bond holder passes away, any unclaimed prizes and their bond investment can be inherited by relatives. The process works as follows:
- Inform NS&I of the death and provide a copy of the death certificate.
- Complete an inheritance form sent by NS&I.
- Provide documents to verify your identity and relationship to the deceased.
- NS&I will update the account and bond ownership to the heir.
Inherited premium bonds remain eligible for prizes in future monthly draws. The £50,000 personal limit does not apply to inherited bonds.
Can I buy premium bonds for children?
Yes, you can buy premium bonds as gifts for children under 16. These will be registered in the child’s name but controlled by an appointed parent or guardian until they turn 16.
Children have their own £50,000 premium bonds limit. So buying them as gifts does not count towards the adult’s allowance.
However, any prizes won will be paid to the parent or guardian’s bank account until the child turns 16. At 16, bond control transfers to the child.
Can I buy premium bonds by Direct Debit?
Unfortunately, you cannot set up a Direct Debit to make regular premium bond purchases. You need to buy them as one-off transactions instead.
However, NS&I does offer a standing order facility. This allows you to instruct your bank to send regular fixed payments to fund new premium bonds.
The minimum standing order amount is £25. You can set up a standing order by calling NS&I or via your online account.
How do I buy premium bonds?
You can purchase premium bonds in the following ways:
- Online via the NS&I website.
- By phone through the NS&I call centre.
- By post by mailing an application form and cheque.
- In person at selected Post Office branches.
To buy online, you just need to register for an NS&I Direct Saver account. You can then use your account to purchase bonds with a debit card or bank transfer.
Buying by phone also requires an existing NS&I account. Postal applications allow new customers to get started.
What are some alternatives to premium bonds?
While premium bonds offer tax-free prizes, they do not pay interest. If you want to earn income on your savings, some alternatives to consider are:
- Savings accounts – Pay interest income on your deposits.
- Cash ISAs – Tax-free interest on savings up to £20,000 per year.
- Fixed bonds – Lock your money away to earn a fixed rate of interest.
- Investment funds – Invest in stocks, shares and other assets to seek higher returns.
- Peer-to-peer lending – Earn interest by lending your money to other people.
These options provide more predictable returns in the form of interest or investment income. However, they lack the excitement and tax-free perks associated with premium bonds.
The pros and cons of premium bonds
Here is a quick summary of the key advantages and disadvantages of premium bonds:
Pros
- Prizes are completely tax-free
- Your capital is secure and backed by the government
- Easy access to get your money back when needed
- Prizes are additional to return of your capital
- Fun and excitement from the monthly prize draws
Cons
- Your money does not earn interest
- Prize payouts are not guaranteed
- Small chances of winning the jackpot prizes
- Capital can be eroded by inflation over time
- Maximum investment limit of £50,000 per person
Are premium bonds worth it?
Whether premium bonds are ‘worth it’ depends on your personal financial situation and savings goals.
The tax-free prizes provide an extra incentive versus normal savings accounts. However, the average return is generally quite low once you account for the lack of interest.
Premium bonds may appeal if you have already maxed out other tax-free savings like ISAs. The prizes add a fun lottery-style element to saving which some people enjoy.
But pure financial return should not be the only motivation. As an ultimately safe savings option backed by the government, premium bonds have an appeal for some risk-averse savers.
Key takeaways
- Premium bonds provide prizes instead of interest on your savings.
- Your original investment is always secure as the money is held by NS&I.
- Prizes are tax-free under current UK law.
- Odds of winning are based on a monthly prize draw with over 1.4 million prizes.
- Maximum investment is £50,000 per person or child under 16.
- You can withdraw your money whenever you want.
- Premium bonds are considered a very safe savings option.
Conclusion
Premium bonds offer a fun and tax-free way to save with the added bonus of being entered into monthly prize draws. While they do not pay interest, the prizes provide an extra incentive for savers.
With full capital security and government backing, premium bonds appeal to security-focused investors. However, the low average returns may not be suitable for those seeking purely financial gain from their savings.
As with any investment product, premium bonds have both advantages and drawbacks to weigh up. But their tax-free prize draws and safety make them a unique option amongst savings accounts available in the UK.
