Time to ditch premium bonds?

Premium bonds have long held a special place in the nation’s hearts. Despite not paying any interest, the lottery bonds are the most popular savings method in the UK – a staggering 21 million of us hold them. But if you are foregoing a guaranteed return on your savings in the hope that you are going to win big, be warned. The number of large prizes has just been cut again. From May this year, there will be one fewer of the £100,000 prizes handed out every month (there will be only two from then on) and there will also be two fewer £25,000 prizes (nine instead of 11). Your chances of winning any prize at all won’t change – the odds will remain a lengthy 30,000 to one – but there will be more £25 prizes to make up for cuts to the number of bigger prizes.

The cut in the frequency of big prizes is happening because National Savings & Investments (NS&I) is cutting the prize fund rate. This is set in line with typical savings rates and is currently 1.25%, but will fall to 1.15% in May to reflect falling interest rates across the savings market. “The new rates reflect current market conditions and allow us to continue to strike a balance between the needs of our savers, taxpayers and the stability of the broader financial services sector,” says Steve Owen of NS&I.

In these glum times for savers, the hope that they could be next month’s jackpot winner seems to keep premium bond holders going. “Ironically, with so little interest on cash for savers, premium bonds look more attractive – if your savings are returning basically nothing, you might as well opt for the chance of a jackpot prize,” Danny Cox, chartered financial planner at Hargreaves Lansdown, told the BBC. There are other benefits too. Your money is 100% guaranteed by the Treasury, making it the most risk-free thing you can do with your savings, and the prizes, should you win, are tax-free.

However, this cut to the prize fund should act as a wake-up call to premium bond holders. If any other savings account saw a cut in its interest rate, customers would be heading for the door looking for a better deal elsewhere. But the number of people holding premium bonds doesn’t ever seem to be affected by falling prize rates. If you want your money to keep up with inflation, you are better off moving it to an account paying you a guaranteed rate of return.

Better places for your savings

Leave your money in premium bonds, and the low average returns mean inflation is likely slowly to eat away at the value of your savings. There are far better choices. If you want the state-backed safety of NS&I, then consider the investment guaranteed growth bond, which is being launched this spring. This is also 100% guaranteed by the Treasury, but is expected to pay 2.2% interest for three years.

Alternatively, if you only hold a small number of bonds, move your money into a high-interest account. Tesco Bank’s current account that pays 3% interest on balances up to £3,000 has proved so popular that the bank has had to stop accepting new applications. But Tesco says this is only a pause, so be ready when it reopens. In the meantime, Nationwide’s FlexDirect account pays 5% interest on balances up to £2,500, provided you pay in £1,000 a month.

If you are prepared to take a significant step up the risk scale, then look at peer-to-peer investing. You can get returns of up to 6% with the likes of Zopa, RateSetter and Funding Circle – but your money won’t be covered by the Financial Services Compensation Scheme. So, if the peer-to-peer firm goes bust or losses on loans are greater than expected, you could lose your savings.

Finally, if you like the thrill of a prize draw, there are ways you can earn interest at the same time. Halifax’s Savers Prize Draw pays out three jackpot prizes of £100,000 each month, plus thousands of smaller prizes. To enter, you have to hold £5,000 in qualifying Halifax accounts. The interest rates aren’t table-topping – 0.65% for a one-year Isa or 0.25% for an easy-access account – but at least it beats premium bonds.

In the news this week…

• Many people who set up trusts to limit inheritance tax (IHT) liabilities need to hurriedly “re-arrange their affairs” or risk missing out on a “valuable new tax perk”, says Sam Brodbeck in The Daily Telegraph. Roughly 16 million adults have written wills; of those, especially those written prior to 2007 (the year IHT rules changed), many are likely to have included a trust. However, from 6 April this year, the new “family home allowance” for IHT takes effect, and trusts are “explicitly excluded” from this.

The allowance is generous: by 2020-2021, at which point the changes will have been fully rolled out, couples will be able to pass on a £1m property IHT-free. Given that the trust itself is not triggered until the death of the first parent, beneficiaries then have two years from the death of the second parent to “disband the trust”, using a “deed of variation” to make sure they can use the allowance. All parties – beneficiaries and trustees – must agree. If nothing is done in that time, beneficiaries will have to stick to the original will, and the allowance is “lost for good”. 

• Pensioners also need to act by the end of the tax year to snap up a “rare government offer” to “turbocharge” their retirement income, says Teresa Hunter, also in The Daily Telegraph. The government offered up to 12 million people who reached state pension age before April 2016 the chance to “convert a lump sum into a guaranteed income for life on terms that are up to 133% better than those available on the open market”; yet the public has “largely ignored” it. Those who qualify can effectively buy a “government-backed index-linked annuity that pays almost 6% at the age of 65”, compared with 2.5% on the open market.

When the scheme was launched in 2014, the decision wasn’t so clear-cut; now that interest and annuity rates have fallen, the “attractions have grown substantially”. “Almost everyone”, apart from pensioners paying higher-rate tax with a lower life expectancy, would “gain by taking part”, says pension consultants Hymans Robertson. Since individual circumstances may affect the desirability of this course of action, interested parties should seek financial advice.