Martin Lewis has explained a five-year rule that Premium Bonds holders may not realise applies to their savings. He also explained when the NS&I scheme can be a "decent bet" compared to other savings options.
The savings expert was asked on his BBC podcast to explain how tax on savings works. One way to avoid tax on your savings growth is through Premium Bonds, as any prizes you win in the monthly draw are tax-free. This is particularly attractive if you win one of the big prizes - there were several £100,000 and £50,000 wins for Bond holders in Wales in the November draw.
Tax-free perks
Looking at the key rules for the NS&I scheme, Mr Lewis said: "You've got Premium Bonds, where you don't have a yearly allowance, you have a maximum £50,000 that you can put in tax-free." You can hold up to £50,000 in Bonds, with each £1 Bond that goes into the monthly draw having the same chance of winning a prize. The odds of winning for each £1 Bond are currently 21,000 to one.
Mr Lewis said: "Generally I'm not the biggest fan of Premium Bonds for small amounts and for people who don't pay tax on savings. But if you're, say, a higher rate taxpayer, you do pay tax on savings, and you're putting a larger amount in, then Premium Bonds can be a decent bet compared to other savings."
Tax-free allowances
You can grow your savings tax-free in several ways:
- You can put up to £20,000 a year into ISAs. Any growth within these accounts is tax-free.
- If you are on the basic rate for income tax, outside of your ISAs, you can earn up to £1,000 in cash interest each year tax-free. Beyond that, you currently pay 20 per cent tax on your interest, the same as your marginal tax rate.
- For higher rate taxpayers, your allowance is slashed to £500, and you pay 40 per cent tax on your interest.
- For additional rate taxpayers, you get zero allowance, so you pay tax on any interest earnings outside of an ISA. The tax rate for this group is 45 per cent.
- If you are growing your savings through investments, outside of your ISAs, you may have to pay capital gains tax, but you can realise gains of up to £3,000 a year without paying this tax.
The Government announced at the Autumn Budget that the tax rates you pay on your taxable interest earnings will increase by four percentage points, across all categories. The new tax rates will come in from April 2027.
5-year rule
However, there is an important 5-year rule to bear in mind if you are considering Premium Bonds as a saving choice. Mr Lewis said: "If you're putting stuff away for a long period over 5 years, you should be looking at investing more than saving anyway, and it's just important for me to state that."
The consumer expert often points to this rule that if you have a pot of emergency funds in place and you have an amount of savings you won't need to access for at least five years, then investing these funds may be the best choice.
Investments typically need at least five years to consistently grow - as stocks and shares can go up and down in value. Mr Lewis explained: "You want to focus on investing, because that will tend, in a broad spread of investments — something like a global index tracker, which is what the independent financial advisers always tell me is the start point to go to — will tend to outperform savings."
