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Saturday Money: An extra millionaire a month, thanks to Ernie: Premium bonds With two pounds 1m prizes up for grabs, Rupert Jones works out whether to have a punt - or put cash in a savings account

August 2, 2014

Rupert Jones



Britain's 21 million-strong army of premium bond holders has been given a boost this week, with the number of pounds 1m tax-free prizes increasing to two a month.

National Savings & Investments (NS&I) has also nudged up the premium bond "prize fund rate" - the proportion of the total amount invested paid out in prizes - from 1.30% to 1.35%.

Yesterday's rate increase is the first for almost five years. Concern had previously been expressed in some quarters that if the prize fund wasn't upped, more pounds 1m jackpots would have meant fewer smaller prizes, which many people rely on for regular returns.

But is it still worth having a flutter on premium bonds? How do the returns stack up against standard savings accounts and cash Isas? And what are the odds of winning a prize?

In recent years Britain's savers have ploughed billions of pounds into premium bonds, with many taking the view that as savings rates are so paltry, they might as well have a bit of fun with their cash and hopefully win some money.

The government has responded to this enthusiasm by increasing the maximum that can be invested in them. The limit rose from pounds 30,000 to pounds 40,000 in June, and will go up to pounds 50,000 next year.

Meanwhile, NS&I has gone back to having two pounds 1m jackpots per month. It had originally moved from one to two pounds 1m prizes a month in 2005, but then ditched the second four years later.

The good news is that even though it is creating an extra millionaire each month, NS&I isn't (for the moment) penalising its bond-holders by cutting back on the other prizes it hands out.

The total prize fund for this month is estimated at pounds 55.5m - up from just under pounds 52m in July. And the number of prizes in every value category, bar one, is increasing. Higher-value prizes (pounds 5,000-plus) now make up 7% of the prize fund, up from 5% last month.

Many premium bond loyalists used the June increase in the maximum limit as an opportunity to top up their holdings. The total number of eligible bonds in the draw has surged by more than pounds 1.3bn since the start of June.

The result of all of this is that even though the annual prize fund rate has risen slightly, your chances of winning have stayed the same.

NS&I says the odds of winning a prize with each pounds 1 bond number remain unchanged at 26,000 to 1. At least that's better than the 36,000 to 1 that applied during most of 2009.

Because it is tax-free, the new 1.35% prize fund rate is equivalent to a return of 1.69% a year for a basic-rate taxpayer and 2.25% a year for a higher-rate taxpayer.

However, it's more complicated than that. Martin Lewis at the website MoneySavingExpert.com argues that the way the prizes are allocated means most people will receive a return that is less than the declared annual 1.35%.

That rate would imply that you could expect to win pounds 1.35 per pounds 100 of bonds. However, that is impossible, as the smallest prize is pounds 25. Lewis says the jackpots "skew the payout average and make the interest rate look far more generous" than it is.

The premium bonds calculator on his website suggests that someone with pounds 100 in premium bonds, and who enjoys "average luck", has a 95.5% probability of winning nothing over one year.

By contrast, someone with the maximum pounds 40,000 stashed away could, with average luck, expect to win roughly pounds 450 over one year - and their probability of winning pounds 500 or more is 45%. Their chance of winning pounds 1m during that period is said to be one in 98,850.

Some people will feel they can do better than a rate of 1.35%. There are tax-free cash Isas that pay more than that - NS&I offers the Direct Isa, a no-notice account currently paying 1.5%.

And if you are prepared to lock your cash away in a standard fixed-rate savings bond for several years, you can get quite a bit more.

Leeds building society has just launched a 10-year bond paying 4% gross per annum, where your interest is paid monthly. That 4% equates to 3.2% net for a basic-rate taxpayer and 2.4% for a higher-rate taxpayer.

So how much interest might someone earn if they put their pounds 40,000 into a standard savings account for a year?

If they put that amount into an easy-access account paying 1.5% gross per annum (Kent Reliance has an account paying this rate), they would receive around pounds 483 interest as a basic-rate taxpayer, or around pounds 361 if they are a higher-rate taxpayer.

On that basis, the higher-rate taxpayer is better off at National Savings (picking up around pounds 450 in prizes), compared to pounds 361 interest on a 1.5% savings account. But if they are prepared to lock the cash away in a 10-year bond paying 4% gross, they would earn pounds 1,299 as a basic-rate taxpayer, and pounds 971 if a higher-rate payer. Both examples assume interest is calculated and compounded monthly.

It is obviously not fair to compare accounts such as the Kent Reliance product and the Leeds's 10-year bond with premium bonds. The Kent Reliance account is a branch-only easy access account, and the Leeds bond allows no withdrawals until October 2024, while you can cash in premium bonds whenever you like without having to give notice.

However, this at least gives a flavour of how the potential returns from premium bonds compare to those from savings accounts.

It also, perhaps, illustrates how premium bonds can be quite a good bet for certain people, such as higher-rate taxpayers who have cash they might need access to in the coming months.

Danny Cox at investment firm Hargreaves Lansdown says someone in this position - who might be holding on to money in order to pay a tax bill in a few months, or finance a property purchase - may want to consider premium bonds, on the grounds that the prizes they might win may be better than the "miserly" after-tax interest rates they would receive by putting their money in an accessible savings account.

The "absolute security" that premium bonds offer will also appeal to some. However, they are less good for basic-rate taxpayers, Cox adds.

What you need to know:

* Anyone aged 16 or over can buy premium bonds in their own name. You can also buy them for your child or (great) grandchild under 16

* Instead of receiving interest, you get the chance of winning prizes ranging from pounds 25 to pounds 1m

* Each pounds 1 invested buys a unique bond number with a "separate and equal" chance of winning. The winning numbers are chosen "completely at random" by Ernie, says NS&I

* Ernie stands for "electronic random number indicator equipment". "He" was invented in 1956 by one of the original Bletchley Park code-breakers. He's now in his fourth generation

1/8 Any prizes you win are free of income tax and capital gains tax

* NS&I says that "each pounds 1 bond number has exactly the same chance of winning, no matter when or where you bought your bonds"

* Each investment you make must be at least pounds 100 (or pounds 50 if you buy by standing order or bank transfer). You can now hold up to pounds 40,000 in bonds

* You can cash in your bonds whenever you like, without having to give notice

* Premium bonds are vulnerable to inflation, which will reduce the true value of your money over time

Captions:

Early draws: premium bonds go on sale to the public in 1956


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Guardian (UK)


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