Premium Bonds holders have been urged to bear in mind a key rule that applies to any customer's holdings. A financial expert warned this key figure is "one of the most overlooked aspects" of how the savings scheme works.
With Premium Bonds, rather than getting an interest rate applied to your holdings, each £1 you hold is an entry into a monthly prize draw, with a chance of winning big prizes. If you don't win anything, your holdings simply stay the same.
Changes to odds and prize fund rate
NS&I is increasing the odds of winning from the September draw, up from 22,000 to one to 21,000 to one, so you have a better chance of a win in future. The prize fund rate is also going up from 3.8 per cent to 4.35 per cent.
But the reality is if you don't win anything, you may well be losing out in real terms. Tim Grimsditch, managing director at financial support provider Unbiased, said: "This is one of the most overlooked aspects of Premium Bonds. While capital is protected, the spending power of that money can gradually fall if inflation rises faster than returns."
Loss in real value
He showed how this can eat into the value of your cash over time, if you have a fairly large amount invested in Bonds hoping for a big win. The expert said: "If inflation is running at 3 per cent and a bondholder doesn't win any prizes over a year, the real value of their savings effectively falls by 3 per cent.
"An £10,000 holding would still be worth £10,000 on paper, but it would buy roughly £300 less in goods and services than it did a year earlier." The latest inflation figures were not far off this figure, coming in at 2.9 per cent for the year to July, up from 2.6 per cent for the year to June.
Mr Grimsditch spelled out the reality for Bond holders: "Premium Bonds shouldn't automatically be viewed as a risk-free way to grow savings. The capital is secure, but there's still a risk that inflation gradually eats away at the real value of the invested money, especially during long periods without any wins."
The guidance on the NS&I website does include a word of caution about this. Customers are warned: "Remember that inflation can reduce the true value of your money over time."
Time for a review?
Even if you have bagged some wins recently, it may be worth your time looking at alternative options to Premium Bonds. The vast majority of prizes each month are for small amounts such as £25 or £50 - even if you win a few of these, you may get better returns over the long term with an interest rate or through investing.
Mr Grimsditch suggested several other accounts that may be worth a look. He said: Cash ISAs - these remain one of the "strongest options" as you get "guaranteed returns with tax-free interest". Top-paying easy-access accounts - if you want flexibility with how you access your funds. Fixed rate bonds - if you are happy to lock away your cash for a set period.
Tax misunderstanding
One perk of Premium Bonds is all your prizes are paid out tax free. But Mr Grimsditch warned not to "overestimate" this advantage as you can often get higher tax-free returns elsewhere. He said: "For most people, a Cash ISA will often provide greater long-term value because the returns are both tax-free and guaranteed."
"It's also important to remember that many savers can earn interest from standard savings accounts without paying tax because of their Personal Savings Allowance. Basic-rate taxpayers can typically earn up to £1,000 in savings interest each year before tax becomes payable, while higher-rate taxpayers can usually earn up to £500."
Any growth within an ISA is tax-free. You can deposit funds into cash ISAs which grow in line with an interest rate, or you can also buy stocks and shares through an ISA wrapper. Any growth in your investments will likewise avoid a HMRC bill.
