Are premium bonds a good investment for children?

Our Prudent Parent weighs the perks and pitfalls of a much-loved British savings vehicle.

The British public has long had a love affair with premium bonds, but the figures show that buying premium bonds for children or grandchildren is likely to be an unrewarding relationship. My own experience is a good example: I have a few hundred pounds in premium bonds from my late grandparents. Over about 20 years, I have won £50.

Yet the attractions are clear: the bonds are backed by the government (so capital is safe unless the UK goes bust), with monthly prizes from £25 to a life-changing £1 million.

Returns are tax-free, but this is not the lure it once was, as the introduction of the personal savings allowance in April 2016 allows basic-rate taxpayers to earn £1,000 (higher-rate taxpayers £500) tax-free each year, so you would need to have a significant sum stashed away in cash before tax became an issue.

Ultimately, the Achilles’ heel is inflation, as most premium bond holders will see the value of their capital slowly whittled away in real terms. The annual prize fund interest rate stands at 1.4%, below the 2.3% rate of CPI inflation in November. Moreover, the prize pot is not split equally, so the interest rate of 1.4% does not reflect individual experience – in reality there are far more losers than winners.

While the prospect of landing a big win is enticing as well as fun, the main way to beat inflation over the long run in the current climate is in the stockmarket.

Premium bonds are a gamble: if you don’t win, you lose interest that could have been earned elsewhere. It’s not savvy to take that risk and have premium bonds forming the bulk of savings for children or grandchildren.

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