Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

I put the bulk of my cash savings into Premium Bonds three years ago - now I’m wondering if that decision still makes sense.

The financial world has transformed since 2021. Back then the Bank of England was holding official interest rates down at 0.1% - and the rates you could get on cash savings were not much better. My cash was held in a savings account paying 0.51% which, believe it or not, was competitive at the time. Against that backdrop Premium Bonds made sense as a home for this money.

This is ‘rainy day’ money - the pot of cash I keep on hand for real emergencies, like a loss of income. It is separate from investments, where most of my savings are held. Holding some cash - between three and six months’ worth of income which you only use in an emergency - is an important part of any financial plan. Having that level of cash means I can worry less about needing funds in a hurry and, in turn, it allows me to be more relaxed about the performance of the investments I have.

Premium Bonds don’t pay interest, of course, but pay out prizes instead. That makes a straight comparison with savings accounts tricky, but you can make an informed choice between the two if you understand how Premium Bonds work.

Issued by National Savings & Investments (NS&I), the state-backed savings provider, each Premium Bond is worth £1 - although the minimum amount you can purchase is £25. Bonds are entered into a monthly draw with prizes ranging from £25 to £1million. NS&I publishes an ‘annual prize fund rate’ which is the average return received by Premium Bond holders each year via prizes, although you won’t necessarily get that rate - more on that below.

The annual prize fund rate three years ago was 1% - almost double the interest on offer from my savings account. That was enough to persuade me to take a chance on Premium Bond prizes to give me a return on my savings.

What’s the case for Premium Bonds now?

The Premium Bonds annual prize fund rate has risen appreciably since 2021 and is currently 4.4%. That reflects rises in interest rates more widely, although Premium Bonds are not directly determined by the Bank of England or indeed any other market interest rate.

Instead, NS&I sets the prize fund rate to balance various competing objectives. It has a remit to provide a competitive rate for savers, but also to achieve value for money for taxpayers - NS&I is government backed and the money it holds provides a source of financing for the Treasury. Meanwhile, it is required not to distort the commercial savings market by providing rates other providers cannot compete with.  

You can see how the prize fund rate has compared to savings rates in the chart below. The blue line shows the typical rate achieved by cash ISA investors, based on figures collected by the Bank of England and weighted by volume.

Note that the best rates available to savers are likely to be above the level indicated here - the Bank of England figures are an average and give extra weight to the rates from large banks and building societies, but these tend not to be the most competitive. For example, the best rates currently available on Cash ISAs with instant access are above 5%.

On the basis of that - provided I use one of the best paying accounts - it appears to make sense to move my money out of Premium Bonds and into a best-buy savings account. There are a couple of other considerations, however, still to take into account.

Firstly, the Premium Bonds prize fund rate of 4.4% is only indicative - I might win more or I might win less. Because of the way Premium Bonds work, it is generally true that the more bonds you have the greater the chance you have of achieving - or exceeding - the prize fund rate.  With the amounts I have I’m happy that I’d have a decent chance of achieving the prize fund rate.

Secondly, Premium Bonds prizes are tax-free whereas returns from cash savings may be taxed as income. The exceptions to that are if they are held inside an ISA - which means using some of my ISA allowance for cash rather than investments - or if the return is lower than the Personal Savings Allowance. This is set at £1,000 for basic rate taxpayers, £500 for higher-rate taxpayers and zero for additional rate taxpayers.

Taking all these things into account, it makes sense for me to move a chunk of my savings into ISAs - but only using allowance I won’t take up with investments. To allow me to easily move money between cash and investments I will use a cash fund within my Stocks & Shares ISA. Right now, the most popular cash fund has been the Fidelity Cash Fund and this has a distribution yield of 4.97%. Please note this is not guaranteed.

A smaller chunk can be put into cash savings outside of ISAs where the interest they earn will fall within the Personal Savings Allowance. The best rate currently available is 5.06% at the Post Office.1

Finally, a chunk will remain in Premium Bonds where prizes are tax-free - and I can still dream of winning big in the monthly draw.


MoneySavingExpert, 11 April 2024

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. An investment in a money market fund like the Fidelity Cash fund is different from an investment in deposits, as the principal invested in a money market fund is capable of fluctuation. Fidelity's money market funds do not rely on external support for guaranteeing the liquidity of the money market funds or stabilising the NAV per unit or share. An investment in a money market fund is not guaranteed. The value of shares may be adversely affected by insolvency or other financial difficulties affecting any institution in which the Fund's cash has been deposited. Tax treatment depends on individual circumstances and all tax rules may change in the future. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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