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Premium Bonds vs ISA: which is the best home for your money?

Premium Bonds and ISAs are two popular options for saving or investing your money. Each brings a different set of opportunities with various pros and cons.

If you want to find out which is best between Premium Bonds vs ISA, this article has everything you need to know.

Key takeaways

  • The main difference between Premium Bonds and an ISA is that Premium Bonds are a type of government-backed lottery that pays out prizes through a random monthly draw. In contrast, ISAs are savings or investment accounts that allow you to save up to a certain amount each year. Both have tax advantages.
  • There are several different types of ISAs, so it’s essential to identify the type that best suits your needs.
  • ISAs have a £20,000 annual limit, whereas Premium Bonds allow you to pay in up to £50,000.
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  • The number one choice for ISAs
  • Open an ISA account for £9.99
  • Contribute as little as £25 per month

Important information - investment value can go up or down and you could get back less than you invest. If you're in any doubt about the suitability of a Stocks & Shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.

What exactly are Premium Bonds?

Premium Bonds are offered by National Savings and Investments (NS&I), the state-owned savings bank backed by HM Treasury.

When you buy Premium Bonds, you’re entered into a random lottery in which you have the chance to win varying amounts of money. The maximum Premium Bond prize available is £1 million.

Premium Bonds are a favourite of investors, as the fact that they’re backed by the Treasury means you’re always guaranteed to get your money back.

As of February 2022, around 21 million people have a whopping £116 billion invested into them.

How do Premium Bonds work?

A single Premium Bond costs just £1, and each one will be entered into the prize draw once you’ve held them for at least a month. The more you own, the higher your chances of winning a cash prize.

While each Premium Bond costs just £1, the minimum number you can buy is 25 (so £25 worth of bonds).

Winners are then chosen monthly, entirely at random by ERNIE (Electronic Random Number Indicator Equipment).

The lowest value of the prize starts at £25 and increases in increments until it reaches £1 million. Only two holders win the big prize every month.

All prizes are entirely free from tax, including Income Tax and Capital Gains Tax (CGT).

If you’re lucky enough to win, you can either take your prize in cash, have it sent directly to a nominated bank account, or have it automatically reinvested into more Premium Bonds.

How do I buy Premium Bonds?

You can purchase Premium Bonds online on the NS&I website, by phone, or by post.

The minimum investment is £25 for online purchases and for regular standing orders. The maximum amount of bonds you can hold at any given time is £50,000.

If you want to find lost Premium Bonds that you think you may have, NS&I will send you a replacement Bond record on request.

What are the odds of winning?

The more single bonds you hold, the higher your chance of winning Premium Bond prizes.

Your odds of winning the lowest prize of £25 in a month are around 1 in 34,500 for every £1 bond. Jump to the £50,000 prize, however, and you’re staring down odds of 1 in 6,088,113,263.

For the biggest prize of £1 million, which only two people win every month, you’re facing odds of 1 in 57,837,067,198 for every £1 bond.

How does interest on Premium Bonds work?

You won’t directly earn interest on Premium Bonds. Instead, the interest generated is used to fund the monthly prize draw.

For example, if you invest £10,000 and you never win, your money is still worth £10,000 when you come to withdraw. You won’t have earned any interest.

The annual prize fund rate is 1%, as of February 2022.

What are the advantages of Premium Bonds?

Chance to win a big cash prize

You could potentially win large cash prizes with Premium Bonds, ranging from £25 to £1 million.

Since June 1957, Premium Bonds have paid out 552 million tax-free prizes worth approximately £22.6 billion.

Backed by the Treasury

Premium Bonds allow you to sleep easy at night as NS&I is backed by the Treasury, so your money is 100% protected.

Automatic reinvestment

Rather than cashing out when you win on Premium Bonds, you can reinvest the money automatically, which means your chances of winning increase every time you win.

Cash in at any time

You can cash in all or part of your Premium Bonds at any time, without any penalty or charge.

What are the disadvantages of Premium Bonds?

Low odds of winning

Although there are huge prizes on offer, your odds of winning can seem fairly slim. In fact, there is no guarantee that you will win anything. Many people hold bonds for years without winning a prize!

No interest earned

There is no actual interest on money invested into Premium Bonds, so unless you win one of the prizes, you won’t see a return on your investment. While you are guaranteed to get your investment back, you may only get back what you paid in.

This can be an issue because of inflation. Over time, the rising cost of living means goods and services become more expensive. So, if you don’t earn any interest on your savings, your money is worth less in real terms in the future than it is now.

No regular income

If you were hoping to rely on Premium Bonds as a source of regular income, they aren’t for you. As prizes are generated randomly you can’t ever rely on receiving a return from your bonds on a regular basis. Indeed, you may rarely win a prize at all.

How do ISAs differ from Premium Bonds?

Premium Bonds act like a lottery in which prizes are distributed randomly and your chance of winning depends on how many bonds you hold. You don’t receive regular interest or returns.

Meanwhile, ISAs are tax-efficient savings and investment accounts that either pay a specified rate of interest or can generate returns depending on where your money is invested.

There are also differences in the amount of money that can be deposited. As previously mentioned, with Premium Bonds the maximum amount you can hold is £50,000. ISAs, however, have an annual allowance limit. This is £20,000 in the 2021/22 tax year.

Finally, Premium Bonds are backed by HM Treasury so you are guaranteed to get your money back. ISAs are typically held with banks, building societies, or investment providers and, while £85,000 of your savings is protected by the Financial Services Compensation Scheme (FSCS), you’re not 100% guaranteed to get all of your money back if your provider fails.

What different types of ISAs are there?

Cash ISAs

A Cash ISA is a savings account that allows you to earn tax-free interest on your savings. This means you’re protected from Income Tax and Capital Gains Tax (CGT).

You also have the option to choose either an instant-access or fixed-rate Cash ISA.

With a fixed-rate Cash ISA, you’re committing to holding your money in the account for a certain period. This will typically be in return for a slightly higher interest rate. In contrast, instant-access Cash ISAs allow you to access money easily.

Stocks and Shares ISAs

Stocks and Shares ISAs allow you to build a portfolio of investments within the ISA wrapper. You can invest your money in a range of stocks and shares around the world, funds, bonds, and cash.

Returns from a Stocks and Shares ISA are free from Income Tax, CGT, and Dividend Tax.

However, Stocks and Shares ISAs don’t safeguard your investments from Inheritance Tax (IHT).

As with all investing, Stocks and Shares ISAs come with risk – there is no guaranteed or risk-free investment that can be made. Even so, a wide variety of different assets can be purchased.

Lifetime ISAs

A Lifetime ISA (LISA) is a savings or investment account tailored to people aged 18-39 who are saving for their first house or retirement.

You can invest up to £4,000 each tax year into a LISA, and you’ll receive a 25% government bonus on your contributions. This £4,000 counts towards your £20,000 ISA allowance.

That means you can earn up to £1,000 in government bonus each tax year.

However, bear in mind that you’ll face a 25% withdrawal charge if you take money out without using it to buy your first home before the age of 60.

You can either save in a Cash LISA or invest through a Stocks and Shares LISA. Like the other types of ISA, interest or returns are free from Income Tax and CGT.

Innovative Finance ISAs

Innovative Finance ISAs are savings accounts that allow you to make tax-efficient peer-to-peer loans. Peer-to-peer loans mean that investors who want to lend money are paired with would-be borrowers.

The interest rates provided by an Innovative Finance ISA are usually higher than that of a typical savings account, though peer-to-peer lending comes with its own risks.

Peer-to-peer loaning platforms aren’t regulated by the Financial Services Compensation Scheme (FSCS). That means you’ll lose your investment, should the individual or institution to who you’ve loaned money be unable to pay you back.

Innovative Finance ISAs are typically only suitable for experienced or institutional investors.

What type of ISA best suits you?

To decide which type of ISA is best for you, first, you need to identify your reasons for saving and how comfortable you are with risk.

A Cash ISA is typically best suited for someone that wants an extremely low-risk option to save, content with receiving interest on their savings.

Stocks and Shares ISAs are tailored more toward those wanting to try their hand at investing and are comfortable with the risks that come along with this. You’d also normally be looking at a time frame of five years or more.

If your only intention for saving is so you can get on the property ladder, or if you want to start saving for retirement, then a Lifetime ISA is designed for precisely that.

If you’re aiming for higher returns and you’re willing to take on the risk of peer-to-peer lending, then it may be worth looking into an Innovative Finance ISA.

Whatever type of ISA you decide to choose, you still retain the freedom to allocate your money or withdraw it again with a bank transfer back into your bank account.

Can I own multiple types of ISAs?

You can hold multiple types of ISA, and you can spread your ISA allowance across them as you wish.

For example, you can invest £8,000 into your Stocks and Shares ISA, £3,000 to your Innovative Finance ISA, £4,000 into your Lifetime ISA, and a further £5,000 into your Cash ISA. This can be done every tax year.

The main restriction to be aware of here is that you’re only allowed to pay into one of each type of ISA in a tax year. So, while you can hold as many accounts as you like, it’s a better idea to be selective.

What are the advantages of ISAs?

Tax-efficient

One of the most significant advantages of owning an ISA is that your withdrawals are completely tax-free as long as you don’t have a fixed-rate account.

As mentioned previously, this also includes protection from Income Tax, Dividend Tax, and CGT.

Wide variety of investment options

There are a wide variety of options for you to invest in when using a Stocks and Shares ISA, giving you more control over your money. This includes stocks, shares, bonds, gilts, funds, and more.

Power to make decisions

ISAs give you the power to make your own decisions with your money. For example, if you find an ISA provider with much better interest rates, you’re free to switch whenever you want.

What are the disadvantages of ISAs?

The annual ISA allowance

By definition, the ISA allowance restricts the amount of money that can be invested every tax year across all ISAs you may own.

Subject to Inheritance Tax

Although you’re protected from Income Tax and CGT with an ISA, you may still be subject to Inheritance Tax (IHT) should your ISA accounts be passed on to your beneficiary in the unfortunate event of your death. However, this does not apply if your beneficiary is your spouse.

So, which is better between Premium Bonds and ISAs?

The type of investment you decide to make relies on your reasons for saving and investing in the first place and how comfortable you are with risk.

Premium Bonds and Cash ISAs are better for those who don’t need to access their savings immediately and don’t want to take on too much risk. If you are comfortable with not generating a regular return and you’d like the opportunity of winning a tax-free prize, then it could be better to pick Premium Bonds over an ISA.

If you’re comfortable with risk and want to decide where to invest your money, an ISA may better suit your needs, depending on your risk tolerance.

Frequently asked questions

Can I own both an ISA and Premium Bonds?

Yes, you can own ISAs and Premium Bonds at the same time. Better yet, purchasing Premium Bonds doesn’t count toward your yearly ISA allowance.

Can I buy Premium Bonds for my children?

While children below the age of 16 are restricted from buying Premium Bonds, anyone can buy bonds for them. The £50,000 limit still applies.

Please note

The Financial Conduct Authority does not regulate NS&I products.

The value of your investments (and any income from them) can go down as well as up, and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

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