Premium Bonds have been around since 1956 but they’ve recently been in the headlines again after the technology behind the popular saving option has been revamped. But before you put your hand in your pocket, it’s crucial to understand what Premium Bonds are and how they can potentially offer you a return.

Firstly, despite the name, Premium Bonds differ significantly from standard bonds. A bond represents a loan, with the investor receiving specified repayments over a defined period of time, interest may be variable or fixed. They are used by companies, governments and other organisations to raise capital. Premium bonds, on the other hand, are an investment product that doesn’t deliver interest or dividend income. Instead, you’re entered into a prize draw to receive tax-free cash each month.

Introduced over six decades ago by the then Chancellor, and later Prime Minister, Harold Macmillan, Premium Bonds have paid out prizes totalling more than £19 billion. The product was conceived to encourage more people to set savings aside, with the incentive of potentially securing a life-changing, tax-free prize in the process. It’s a strategy that worked, thousands of people use the NS&I product to save.

The evolution of ERNIE

The distribution of the prizes falls to ERNIE; the Electronic Random Number Indicator Equipment.

Every month, ERNIE is fired up and picks which lucky Premium Bonds will win a prize, ranging from £25 to £1 million. The investment product’s recent attention is down to the latest reincarnation of ERNIE being unveiled. Back in the 50s, the original ERNIE was almost the size of a room and took three days to select the random winners. Today, ERNIE 5 is the size of a pea and uses quantum computing to draw three million winners in just 12 minutes.

Since the launch of Premium Bonds, various other products offering cash prizes have launched, such as the National Lottery. But where Premium Bonds differ is that you can withdraw your initial investment, backed by a Government guarantee.

What else do you need to know?

First, for every £1 you invest in Premium Bonds, you’re given a unique number. This is the number you’ll hope ERNIE picks out. As a result, the more money you place in Premium Bonds the greater your chances of winning. NS&I lists the annual prize fund interest rate at 1.4%, but this will vary hugely between different people and even each year on the same Bonds. The odds of winning with a single £1 bond number is 24,500 to 1.

• You can invest as little as £25 through Premium Bonds
• The maximum that can be invested is £50,000
• All prizes are tax-free
• Premium Bonds can be purchased as gifts, including for children aged under 16

Should your purchase Premium Bonds?

As with all financial decisions, this will come down to your priorities.

Premium Bonds do have a certain pull; the thrill of being in a prize draw for £1 million every month is certainly appealing. However, if you’re looking for a regular income or guaranteed returns, they may not be right for you.

You also need to consider the impact of inflation on your savings. As you won’t be generating any interest on your savings, the value will fall in real terms. Inflation refers to the cost of living rising, which means your spending power will decrease if savings remain static. It's important to note that in today's climate of low-interest rates, inflation eating into your spending power should be considered when holding money in cash accounts.

Two of the key initial advantages of using Premium Bonds can also now be found with other savings and investment products.

Security: If ensuring your money is secure, Premium Bonds can be attractive. You know that you’ll be guaranteed the investment you put in when you decide to cash out. However, cash accounts may also suit your needs if this is a priority. Under the Financial Services Compensation Scheme (FSCS), up to £85,000 per person per authorised bank or building society is protected.

Tax-free returns: Choosing to invest in Premium Bonds means any prizes you did win would be received completely tax-free, which can be attractive. But changes to how savings are taxed means it may not be the incentive it once was. The Personal Savings Allowance (PSA) means if you’re a basic rate taxpayer you can earn up to £1,000 in savings income tax-free, or £500 if you’re a higher rate taxpayer. You can also use your annual ISA (Individual Savings Account) allowance, currently £20,000, to save and invest tax-efficiently.

With both these factors in mind, you need to decide whether a guaranteed return is more important to you or a potential ‘big win’ you have a chance of being picked for with Premium Bonds. If you’d like to discuss Premium Bonds in the context of your wider financial plan and goals, please get in touch.  

Please note: The Financial Conduct Authority does not regulate NS&I products or cash deposits.