Are Premium Bonds a poor investment now?

The odds of winning a prize with your Premium Bonds are being cut from 28,000 to one to 30,000 to one. The odds of winning big will drop too, as the number of bigger prizes is being slashed in favour of more £50 and £100 prizes. It begs the question of whether Premium Bonds are worth investing in nowadays.

The cuts kick in this June, and mean that while there will still be two millionaire prizes, there will be two prizes of £100,000 (down from five), five prizes of £50,000 (down from 12), nine prizes of £25,000 (down from 22), 24 prizes of £10,000 (down from 53) and 46 prizes of £5,000 (down from 110).

National Savings & Investments have made the changes because it has a target for the amount of money the government wants it to bring in each year. This has been cut from £10 billion in this tax year to £6 billion in the next tax year. It means that the products don't need to be as attractive - because they are trying to pull in fewer investors - so they can afford to make the cuts.

The upside

Plenty of people hold these bonds - in fact £59.8 billion of them are in the hands of British investors. They don't pay out any interest, instead, there's a draw every month, with the chance of winning one of a range of prizes.

If everyone was averagely lucky, they would win enough to give them an effective interest rate of 1.35% (or 1.25% when the cut kicks in). This isn't anything to write home about, but many investors like the fact there's a chance to win even more - and maybe even to become a millionaire.

If you look at this as a gamble, then it's one of the safest forms of gambling - as you are guaranteed to get your stake back every time, and 100% of your money is protected by the government if something was to happen to NS&I. You are also free to take the cash out at any time if you need it.

The downside

As a gamble, it's not a bad one. As an investment, however, it has its flaws. If you are less than averagely lucky, you will receive little or no interest at all on your investment, and will watch inflation gradually whittle any value away over the years. For the majority of people, their cash would earn more in a savings account.

More of it could be protected in a savings account too, because there's a £50,000 limit to the amount you can hold in Premium Bonds, but the first £75,000 of anything held in a savings account is protected by the Financial Services Compensation Scheme.

If you were prepared to put it away for longer, in a fixed rate bond, then you could easily receive more than 1.25%: at the moment you can get 2% on a two-year-bond and 2.9% on a five-year-bond. That's all without the risk of losing a penny.

One of the big selling points of Premium Bonds has always been that cash prizes are tax-free, so you don't have to pay tax on your payout. This has made them an attractive option - particularly for higher rate taxpayers.

However, from the beginning of the new tax year next week, there's a new personal savings allowance. It means that for basic rate taxpayers the first £1,000 of interest from savings is free, and for higher rate taxpayers the first £500 is tax free. It means that the vast majority of people won't pay tax on their savings - removing a big selling point for Premium Bonds.

It depends

If you hold a large proportion of your savings in Premium Bonds, therefore, there's a strong chance you could see the real value of your investments fall, and you could easily earn a far better guaranteed rate elsewhere.

On the other hand, if you want to hold a small slice of your portfolio in Premium Bonds - in order to gamble without losing your stake - then it may not be such a bad approach to take. Danny Cox, a Chartered Financial Planner with Hargreaves Lansdown adds: "Premium bonds are looking increasingly unattractive, but may still be a solution for higher rate taxpayers looking for a temporary home for some of their cash."