Martin Lewis Premium Bonds advice on £1,000 savings tax risk cash ISA change

Personal finance expert Martin Lewis has given a listener advice on wheher they should pull money out of Premium Bonds and instead invest in an ISA. This week the Bank of England cut interest rates to 4.25% after a slowdown in inflation, meaning savers are concerned at the implications.

People use ISAs and Premium bonds to avoid savings tax. Basic-rate (20%) taxpayers: can earn £1,000 in savings interest per year with no tax. Higher-rate (40%) taxpayers can earn £500 in savings interest per year with no tax.

On Martin’s BBC Podcast Chris from Christchurch asked a question about what she should do with £20,000 currently in Premium Bonds. She said: “This is purely maximising my savings. I’ve got £20,000 in Premium Bonds. It’s been there for quite a while and I have over the last couple of years had quite a good return on them but.” Martin interjected: “Hold on, hold on.” Chris said: “I’ve had one fairly good win and then nothing at all.”

Martin said: “But do you add up, and this is what I’d advise anyone on Premium Bonds to do, do you add up what you win in a year? forget the month, look at is as a yearly interest and if so how much do you win over a year and what would the equivalent interest rate be? Probably the truth is you don’t do that.

“And the entire point of Premium Bonds is to reward you occasionally with an above average win and that sticks in your head and what you forget is all those months when you don’t win anything.”

Chris added: “What I’ve been poring over the last month I follow your blog quite a lot and at the end of last year I maximised my ISAs with a Chip investment,” Martin added: “Just so people know Chip is one of the top paying cash ISA providers.”

Then Chris said: “Over the last few months I’ve every day been going in and looking at the top rates and then keep changing. With the interest going down today [Thursday], are fixed ISAs still the best way forward? And when would be the best time to take the money out of my Premium Bonds and put it into and ISA?”

Martin explained what happens in Premium Bonds compared to ISAs: “Well let’s just do the Premium Bonds comparison. The current Premium Bond prize fund rate is 3.8 per cent but I strongly suspect that is going to drop in the next couple of months on the back of this base rate cut. I’m going to examine it as if it stays at 3.8 per cent. That means for all the money in Premium Bonds 3.8 per cent of it is given out in prizes each month, the smallest of which is £25 and the biggest is £1 million.

“But for everybody who wins £1 million quite a lot of people have to win nothing. When you look at the probability distribution of Premium Bonds what it actually says is if you look at the median person - in other words if we looked at everybody who has the amount of money you have in Premium Bonds how much would the person in the middle get. Median earnings are always lower than the prize fund rate at every level.

“So if you have £20,000 on average, because it’s a decent amount, you’re probably [Martin said he hadn’t worked out this exactly but using his past knowledge] on average likely to win 3.5 or 3.6 per cent and that’s tax free. But then again, your money in the cash ISA is tax-free anyway.

“You asked about top fixed rate cash ISAs - the top at the moment over 1 year pays 4.26 per cent and that’s locked in which is Oak North. The top over 2 years is progressive is 4.3 per cent. Certainly on balance of risk it would actually be quite unlikely for your Premium Bonds to beat a cash ISA. Even though there’s only a 0.3 or 0.4 per cent differential to overcome the fact that someone typical wouldn’t win it, you have to be pretty lucky to beat the top rate cash ISA. The big question for you is - do you have other savings you pay tax on?”

Chris said she’s got about £30,000 in a First Direct bonus account which currnetly gets her about £120 a month. Mr Lewis said as a basic rate taxpayer Chris would have £1,000 interest she could earn tax-free which is already being used through the First Direct account.

Mr Lewis said to protect the money from tax on the interest: “The two main ways are Premium Bonds or cash ISA and I’d use my cash ISA before I use Premium Bonds.” Mr Lewis said if she wasn’t already paying tax on savings, he would have advised to put the money in normal fixed savings accounts. So on that basis he advised a cash ISA fixed rate account, although he said most of the fixed accounts don’t allow more than £20,000 and don’t allow other ISAs to be transferred in there.