Consumer champion Martin Lewis has issued a stark warning to savers overly focused on tax efficiency, suggesting they might be "letting the tax tail wag the dog" when it comes to Premium Bonds. His advice came during a detailed discussion on his BBC podcast, where he addressed a listener's query about building savings for her two children in a tax-efficient manner.
The Premium Bonds Proposition: Tax-Free but Low-Yield
The prize fund rate for National Savings and Investments (NS&I) Premium Bonds currently stands at 3.6 percent, with odds of winning set at 22,000 to one for each £1 Bond. A significant allure of the scheme is its tax-free status; all winnings, from the smallest £25 prize to the £1 million jackpot, are exempt from Income Tax and Capital Gains Tax. This feature makes Premium Bonds particularly attractive to individuals who have fully utilised their other tax-free allowances, such as the annual ISA allowance or the Personal Savings Allowance.
A Listener's Dilemma: Maximising Tax Efficiency
The caller, a mother of two children aged around ten, explained she had already maximised junior ISAs for both youngsters, depositing the full £9,000 allowance per child for the financial year. Seeking further ways to save without incurring a tax bill, she placed approximately £1,500 into Premium Bonds, acknowledging the slim chance of winning but valuing the capital security offered by the Treasury-backed provider.
Research from Lewis's MoneySavingExpert website underscores the challenge: with holdings of just £1,000, the average return is typically zero. Even with a more substantial £10,000 invested, the average rate of return is only around three percent, equating to roughly £300 in prizes annually.
Lewis's Counter-Argument: Prioritise Returns Over Tax Fear
Addressing the caller directly, Lewis cautioned against an excessive focus on tax avoidance. "I think you may be slightly letting the tax tail wag the dog here," he stated. He elaborated with a clear mathematical comparison: "You're saying to me, I've put £1,500 in Premium Bonds even though the median return is likely to be zero, because it protects me from tax. You're not going to pay any tax on zero return anyway. You'd be better to pay 20 percent tax on a four percent return than no tax on a zero percent return."
Practical Alternatives for Better Growth
Lewis suggested the £1,500 could generate stronger results in a competitive savings account. He specifically mentioned options like the Nationwide Flex Saver, offering 5 percent interest, or the Halifax Regular Saver. "That would be my instinct," he advised, noting "there's no right or wrong here, on that particular amount."
Depositing £1,500 in an account with a 5 percent rate would yield £75 in annual interest. Even after a potential 20 percent tax deduction for a basic-rate taxpayer, the net return would significantly outstrip the likely zero return from Premium Bonds with such a modest holding.
The Reality of Premium Bond Prizes
It is crucial for savers to understand the prize distribution. The overwhelming majority of prizes in each monthly draw are for modest sums of £25 or £50. Therefore, even if a saver with £1,500 invested were fortunate enough to win a couple of these smaller prizes throughout the year, the total value would likely still fall short of the returns available from leading easy-access savings accounts in the current market.
While Premium Bonds offer unique benefits—capital security under the Treasury guarantee and the excitement of a potential life-changing win—Lewis's analysis highlights that for those with smaller savings pots, chasing tax-free status may come at the cost of forgone interest. His guidance urges a balanced approach, weighing guaranteed returns against tax implications and the lottery-style nature of Premium Bonds.
