NS&I Premium Bonds now a ‘best buy’ – but are they worth it?

National Savings & Investments (NS&) is increasing the prize fund rate on Premium Bonds from 3 per cent to 3.15 per cent taking it to its highest level in more than 14 years. The increase takes effect from the February 2023 prize draw. It follows an increase in the prize fund rate from 2.2 per cent to 3 per cent at the start of the year and is the fourth increase NS&I has made in the past year.

It means that NS&I Premium Bonds' 'effective interest rate' is among the best available when compared to easy-access savings accounts from other providers. However, NS&I Premium Bonds do not pay interest but rather enter into a draw to win prizes. However, the odds of each £1 bond winning a prize remain fixed at 24,000 to one because NS&I is also increasing the number of prizes worth between £50 and £100,000 from February’s draw. There will be roughly 10 per cent more £50 and £100 prizes, and around 5 per cent more prizes at each level between £500 and £100,000.

While the opportunity of winning a large sum of money is attractive, the chance of this is still very small. Investment platform Hargreaves Lansdown (HL.) says that in an average month the average saver will win nothing. So for many savers it could be better to hold cash savings in easy-access accounts elsewhere which pay up to 2.91 per cent of guaranteed interest – rather than relying on luck.

You cannot hold more than £50,000 in NS&I Premium Bonds, in contrast to up to at least £85,000 (the maximum protected by the Financial Services Compensation Scheme) easy-access cash accounts with market leading rates. NS&I Premium Bonds' effective interest rate is well behind consumer price index inflation (CPI) which was 10.5 per cent in December - though no cash account comes anywhere near this level.

Ben Rogers, chartered financial planner at Equilibrium Financial Planning, says: "Premium Bonds are generally unable to keep up with inflation, meaning that unless you win a big prize, your money will be losing value in real terms, particularly in the current climate. Premium Bonds could be used to hold some money for the short-term, in order to pay a looming bill, for example. They are not worthwhile for those looking to hold large amounts of money for an extended period of time."

Tax benefits and freedom

However, unlike interest on cash accounts, NS&I Premium Bond prizes are tax free. However, the personal savings allowance enables basic rate tax payers to earn interest of up to a £1,000 a year tax free and higher rate tax payers of up to £500 tax free. A downside to increasing interest rates is that larger amounts of cash savings might breach these allowances and incur tax on any interest over your allowance at your usual rate of income tax. You could hold additional cash within an individual savings account (Isa) where it would not incur tax. However, you should prioritise holding funds and shares within tax-efficient Isas – especially as capital gains tax and dividend allowances will fall from April.

Laura Suter, head of personal finance at AJ Bell (AJB), argues that it might even be better to pay tax on any interest which exceeds your personal savings allowance "rather than gambling on Premium Bonds and potentially earning no interest."

However, some easy-access accounts have more restrictions than NS&I Premium Bonds. For example, Paragon Triple Access Savings Account which pays 2.91 per cent, and Nationwide 1 Year Triple Access Online Saver, which pays 2.5 per cent, only allow you to make three withdrawals every 12 months without your interest rate falling to 0.75 per cent.

You can gain even higher returns with some fixed and notice accounts, though you need to be certain that you will not need to have access this money in the short term.

The Bank of London & The Middle East Notice Account (Issue 5) expects to pay an annual equivalent rate (AER) of 3.24 per cent on deposits of at least £10,000 but you have to give 90 days notice before withdrawing your money. Close Brothers 95 Day Notice Account (Issue 14) pays an AER of 3.15 per cent on deposits of at least £10,000 and Mansfield Building Society Postal Savings 35 Day Notice (2nd Issue) has an AER of 3 per cent on deposits of at least £1,000 for the first 12 months of the account, after which the rate falls to 2.4 per cent.

But you can cash in all or part of your NS&I Premium Bonds at any time and invest as little as £25 in them.

Higher earners can benefit

There is a greater argument for additional rate tax payers, who have no personal savings allowance, to consider NS&I Premium Bonds as anything they win will be tax free as oppose to potentially being taxed at 45 per cent. Other options are a cash Isa if they have not used up their annual allowance for higher returning investments. Chris Hood, investment expert at NFU Mutual, says: "While Premium Bonds may be more appealing to additional rate and higher rate taxpayers because of the tax-free prizes on offer, the reality is that many of these people should be investing into their Isas first."

Other NS&I accounts

NS&I has increased the interest rate on its Direct Saver and Income Bonds from 2.3 per cent to 2.6 per cent. This means that the interest on the NS&I Direct Saver is the highest it has been since it launched in March 2010 and the interest rate on the NS&I Income Bonds is the highest since 2008. However, this level of interest is not as attractive as some rates you can get on easy-access accounts offered by other providers (see table).

A benefit of NS&I products is that it is backed by HM Treasury so money deposited in them does not face the risk of a private institution becoming insolvent as it is in effect, guaranteed by the British government. However, if you deposit up to £85,000 in a bank or building society, which is authorised by the Prudential Regulation Authority, you will be compensated by the Financial Services Compensation Scheme. If you have more than this amount, you could hold it in different financial institutions which are not part of the same group with amounts not greater than £85,000 in each.

NS&I has also increased the interest rate on its Direct Isa from 1.75 per cent to 2.15 per cent taking it to the highest level since 2013. But this falls behind the rates you can get on cash Isas from other providers, according to Moneyfacts.co.uk, as of 25 January.

NS&I has increased the interest rate on its Junior Isa from 2.70 per cent to 3.40 per cent so that it now has one of the best rates on the market. If you are looking to hold cash for your child or switch your child's Jisa to another provider to get a better rate, this might be an option.