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What are premium bonds? Everything you need to know

Premium bonds are investment products offered by the British government’s National Savings & Investment (NS&I) in the UK. These lottery bonds work very differently when compared to traditional bonds. The buyers of premium bonds do not get any interest on their investment; however, they become eligible to win monthly tax-free prizes ranging from £25 to £1 million!

Thus, premium bonds are a fun way to save money and win tax-free prizes. You can start with a minimum investment of £25 and become eligible for a draw of lots with odds of 34,500/1 of winning for every £1 bond every month. Every £1 invested generates a unique number that is put in the monthly draw. Investors can end up winning nothing at all and not earning any interest on their savings; however, there is also a chance of winning a big jackpot prize.

How do premium bonds work?

Investors in the UK can start investing in premium bonds with as little as £25, up to a maximum of £50,000. Once the bonds are held for at least one whole month, every £1 becomes eligible for the monthly draw. So, if you buy premium bonds worth £200, you will get 200 unique numbers that will be eligible for the monthly draw. It is also interesting to know that the old premium bonds also remain eligible for the current month’s draw of lots. Thus, if you bought a premium bond in 1990, it is still eligible for the monthly draw in 2021.

The system that generates unique numbers for all premium bonds and picks the winners is called the Electronic Random Number Indicator Equipment or ERNIE. Previous generations used thermal noise to generate the numbers; however, the new generation uses light-powered quantum technology for number-generation. The new system works 42.5 times faster than the older one and generates the entire set of numbers for a monthly draw in less than 12 minutes.

You can buy premium bonds online, over the phone, or by post. You can also purchase bonds for your children under the age of 16 as a savings gift, with all transactions handled by the parent or guardian till they reach 16 years of age. The premium bonds are transferred to the children after they reach the required age.

Overall, premium bonds do not pay any interest on the savings, but the effective interest amounts to about 1% after taking the winning chances into account. With the historically low interest rates in the UK and across the world, the 1% interest rate sounds good; however, not everyone wins the prize and may end up not earning anything at all.

Are premium bonds safe?

Premium bonds are issued by the UK government’s National Savings & Investment (NS&I). Since NS&I is backed by the Treasury, all investments in premium bonds are totally safe. The original investment made in premium bonds remains safe with the NS&I and can be taken back at any time.

On the contrary, premium bonds do not pay any interest. So, if you do not win any prizes, your investment may not remain safe from inflation. The money will not grow; instead, the value of your invested money will corrode with increasing inflation.

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Is it worth investing in premium bonds?

Premium bonds are an obvious favourite in the UK. Over 21 million people have invested more than £88 billion in these bonds – more for the excitement than the returns. They work well for the 100% protection offered by the NS&I, easy access options, and the tax-free nature of the prizes, but they are a gamble at the end of the day.

Premium bonds work as excellent means for tax-free savings. They also come with the added excitement of winning a lottery, and the original investment always remains secure and can be withdrawn whenever needed. Thus, it is worth investing in premium bonds for people who are only looking at saving taxes and some excitement, but not a regular, dependable income. The prizes won through premium bonds are exempt from both income tax and capital gains tax in the UK. It is also important to note that the old premium bonds do not lose their chances to win prizes and can still make you a millionaire even after decades of buying them. For instance, a premium bond bought in 1959 won a £1 million jackpot in 2004.

On the contrary, it is not guaranteed that you will win the lottery. The odds of winning any prizes with the premium bonds are quite slim, and most of the people end up winning nothing at all. Moreover, you may end up losing the value of your saved money due to the impact of inflation in later years. As a result, premium bonds are not worth investing in for people looking for guaranteed returns and regular income. They do not earn any interest, and the returns are not enough to match the cost of living in the coming years.

Comparison of premium bonds with traditional savings accounts

It is evident that premium bonds do not earn any interest, while traditional savings accounts pay some interest for the money saved with them. The 1% prize fund rate of premium bonds is simply an average interest rate for an average number of people winning prizes. There are many who do not win any prizes at all, and the interest rate stands at zero for them.

Therefore, premium bonds were not a recommended savings option for people looking for returns. However, when the 1% prize fund rate of premium bond rates is compared with the all-time low interest rates offered by the traditional savings accounts in the current scenario, the interest rate on premium bonds may turn out to be better in most situations. Also, premium bonds are backed and secured by the NS&I and the Treasury and are much safer than the accounts offered by other banks and financial institutions.

Are premium bonds worth it?

As a bottom line, premium bonds are safe and secure means to save your money tax-free. They do not generate returns in the form of interest; however, there are still chances of winning anything between £25 and £1 million every month. Thus, they are worth investing in for people looking for the flutter of the heart topped with tax-exemptions.

It is advisable, however, not to put all your savings in premium bonds. There are high chances of you winning nothing at all, and you may end up losing the value of your money over time. Instead, the savings can be spread across multiple savings options to ensure that your portfolio remains balanced in terms of risk, returns, tax savings, and its overall value. With some savings generating guaranteed returns and some savings standing a chance to win the jackpot, the investment portfolio tends to remain more balanced and diversified.

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