Holborn Assets Tips – 3 reasons to steer clear of Premium Bonds
The interest rate offered by UK Premium Bonds has been reduced from 1.25% to 1.15%. But is this enough to give Premium Bonds a swerve? The Premium Bonds issued by the British Government are, after all, the UK’s most popular way of saving, with roughly one in three of us saving £68bn between us.
There’s three good reasons why you should consider regular savings accounts or ISAs as equally attractive as Premium Bonds for low-yield, high-safety savings:
1. Premium Bonds tax free? So what? So is all savings interest now up to £1000
One of the key attractions of Premium Bonds used to be that the prizes (the equivalent of an interest payment) are given out tax-free.
But a change in the law in 2016 has largely nullified this advantage of tax-exemption. The new Personal Savings Allowance has meant that 95% of people (the broadly-accepted figure) no longer pay tax on their savings anyway.
The PSA allows you to avoid tax on savings interest up to £1000 pa (basic rate taxpayer) or £500 pa (higher band taxpayers).
The good news for Premium Bonds – particularly for those with large sums to invest – is that prizes do not eat into the tax-free exemption of the PSA. You can win as many Premium Bond prices as you like without affecting your remaining PSA £1000 or £500 tax-free savings interest benchmark; in this way, Premium Bonds operate effectively as a bonus tax-exempt allowance supplementary to the PSA.
2. Premium Bonds – “Government-safe”. So what? £85,000 of your savings are guaranteed anyway by the FSCS.
An advantage that Premium Bonds shares with regular savings accounts is that, because Premium Bonds are issued by a UK Government-owned company, NS&I, your seed capital will not diminish. You will not, in other words lose even 1% of the farm – but bear in mind that the price you always pay for high seed security is low yield potential (ie. the safer the investment, the less potential to make high returns).
The issue here is that the capital in regular savings accounts is also guaranteed up to £85,000 – by the Government-backed Financial Services Compensation Scheme. With the maximum investment in Premium Bonds being £50,000, you can see that the Government-backed safety offered by Premium Bonds is equally and entirely matched by savings accounts. Or is it?
3. 1.15% “interest” offered by Premium Bonds. So what? That doesn’t even beat inflation!
Low interest rates are not a problem confined to Premium Bonds. The official “interest” rate of Premium Bonds is 1.15%. This figure is how prize distribution works out on average over a year). That compares with an interest rate of 1.05% recorded in May 2017 for the top easy-access ISA and 1.71% for the top 2-year fixed savings account. Premium Bonds aren’t exactly offering stand-out value, but a cut from an optimal interest equivalent of 1.25% to 1.15% hasn’t excised them from the market. Bear in mind that, crucially, both for savings accounts and Premium Bonds, the issue is: what are you are going to do about inflation?
If prices rise at a faster rate than the interest on your capital, then effectively over time that seed capital reduces – by relation to what it can actually buy. Although the numerical figure will get bigger (with a possible interest rate of 1.15% paid annually in prizes), the financial power of the sum will be smaller in relation to rising prices.
The Consumer Prices Index stood at 2.3% in March. RPI stands at 3.1%. With an annual interest rate of only 1.15%, it has been calculated that Premium Bonds will effectively halve your seed capital over 30 years if inflation continues as it has done (and it’s potentially only just got going) and you are only averagely lucky.
Premium Bonds – a fair deal
Respected pundit Martin Lewis of moneysavingexpert.com says Premium Bonds are “only a good bet as a serious place to put savings if you’re lucky, or you’re a higher- or top-rate taxpayer who has used up their personal savings allowance, cash ISA allocation, and top bank savings accounts.”
So why do Brits have Premium Bonds still? Surely it’s because it’s fun to enter a lottery but call it serious saving – even though the odds of winning the lowest prize of £25 are 1 in 30k and the odds of winning the second highest prize of £50 shoot up to almost 1 in 1.5m.