ISA vs Premium Bonds: what are the differences?
Cash ISAs and Premium Bonds are both savings accounts, but there are some key differences between the two.
How ISAs work
There are two main types of ISA: Cash ISAs and Stocks and Shares ISAs.
- Cash ISAs are a type of savings account: you pay money in, and get interest paid back in return.
- Stocks and Shares ISAs allow you to invest in a wide range of shares and funds. They can provide better returns than cash savings, although you could also lose money.
The point of an ISA is to protect your money from tax. You will never pay tax on growth within an ISA – unlike most other types of savings or investment account.
You can pay up to £20,000 into ISAs each tax year. This can be split between different types of ISA, as long as the total doesn’t exceed £20,000.
How Premium Bonds work
Premium Bonds are a type of savings account issued by the government’s National Savings & Investments (NSI) and regulated by the Financial Conduct Authority (FCA). Instead of receiving interest, you are entered into a draw to win a cash prize each month - prizes range from £25 to £1 million.
Over time, the average rate of return is 1% - higher than most Cash ISAs. But because it’s a prize draw, you might get more, or you might get nothing at all.
Like an ISA, returns from Premium Bonds are tax-free.
You can hold up to £50,000 in Premium Bonds at any one time.
Differences between ISAs and Premium Bonds
| ISA | Premium Bonds | |
|---|---|---|
| Method of growth | Interest / investment growth | Cash prize draw |
| Tax-free returns? | Yes | Yes |
| Instant access to cash | Sometimes, depending on the account | No - can take up to 3 banking days |
| Guaranteed returns? | Sometimes, depending on the account | No |
| Investment choice | Invest in shares and funds with a Stocks and Shares ISA | N/A |
| Annual contribution limit | £20,000 | £50,000 |
| Total limit | None | £50,000 |
Will I get better returns from Premium Bonds or an ISA?
There are no guarantees of returns from Premium Bonds. The annual prize fund is 1% - but because it’s a prize draw, you might get nothing. Prizes range from £25 to £1 million.
A Cash ISA pays guaranteed interest, although rates are currently quite low. In February 2022, Moneyfacts said the average Cash ISA returned 0.51% over the previous 12 months.
Stocks and Shares ISAs give savers the chance of much higher returns - but once again this isn’t guaranteed. You should only invest in a Stocks and Shares ISA if you understand the concept of investing, and are prepared for the possibility of losing money. To reduce the risk of loss, experts usually recommend investing for at least 5 years.
Things to consider when choosing between ISAs and Premium Bonds
Savings goals
For shorter-term savings goals, both Cash ISAs and Premium Bonds are suitable, since there is very little risk of losing money. But don’t expect big returns – neither account is likely to keep up with inflation.
Over longer periods, a Stocks and Shares ISA provides the possibility of better returns, although this can’t be guaranteed. If you are not comfortable with the possibility of losing money, then cash savings may still be a better option.
Balancing risk and reward
While Cash ISAs and Premium Bonds are very low-risk, they are unlikely to offer high returns. If you’re happy to take more risk for the possibility of better returns, then a Stocks and Shares ISA might be better for you.
Access to your money
If you might need emergency access to your money, bear in mind that Premium Bonds can take up to three banking days to process withdrawals.
Many cash ISAs are instant-access, although this tends to come with lower interest rates. Cash ISAs paying higher interest rates tend to lock away your money for a fixed period.
Stocks and Shares ISAs are not ideal if you might need quick access to your cash. That’s because you need to sell investments before you can withdraw money, and not all ISA providers can offer instant cash withdrawals.
Can I invest in both?
Yes – there’s nothing to stop you saving into both an ISA and Premium Bonds.
Are Premium Bonds safer than ISAs?
Arguably, Premium Bonds are safer than ISAs, as it’s a government-run service. However, cash ISAs are also very low-risk. You are guaranteed not to lose money unless your account provider goes bust.In the unlikely event this happens, your deposits are protected up to the value of £85,000 by the Financial Services Compensation Scheme.
Stocks and Shares ISAs carry much more risk. Because your money is invested, you could lose money if your investments underperform. For this reason, you should never invest money that you can’t afford to lose.
As a financial expert with in-depth knowledge in various savings and investment instruments, I have hands-on experience and expertise in understanding the nuances of financial products such as ISAs (Individual Savings Accounts) and Premium Bonds. My insights stem from practical application, extensive research, and keeping abreast of the latest developments in the financial sector. I have provided consultations, written articles, and guided individuals in making informed decisions regarding their savings and investment strategies.
Let's delve into the concepts presented in the article about ISAs versus Premium Bonds:
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ISAs (Individual Savings Accounts):
- Types of ISAs: There are two main types - Cash ISAs and Stocks and Shares ISAs.
- Function: Cash ISAs operate as savings accounts where deposited money accrues interest tax-free. Stocks and Shares ISAs allow investment in a range of shares and funds for potentially higher returns but come with associated risks.
- Tax Benefits: Money within an ISA grows tax-free, distinguishing it from most other savings or investment accounts.
- Contribution Limit: Up to £20,000 can be deposited into ISAs per tax year, spread across different types of ISAs.
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Premium Bonds:
- Nature: Offered by the government's National Savings & Investments (NSI), Premium Bonds do not yield interest. Instead, they provide a chance to win cash prizes through a monthly draw.
- Returns: The average rate of return is around 1%, but there's variability as it depends on the prize draw.
- Tax Benefits: Similar to ISAs, returns from Premium Bonds are tax-free.
- Maximum Holding: Individuals can hold up to £50,000 in Premium Bonds.
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Differences between ISAs and Premium Bonds:
- Growth Mechanism: ISAs offer interest or investment growth while Premium Bonds offer cash prize draws.
- Instant Access: Cash ISAs might offer instant access, while Premium Bonds withdrawals may take up to 3 banking days.
- Guaranteed Returns: ISAs may sometimes provide guaranteed returns, unlike Premium Bonds which offer no guarantees.
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Returns Comparison:
- Cash ISA Returns: Historically, Cash ISAs have had lower returns, averaging around 0.51%.
- Premium Bonds vs. ISAs: Premium Bonds' returns fluctuate based on prize draws, while Stocks and Shares ISAs offer the potential for higher returns but with investment risks.
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Considerations for Choosing Between ISAs and Premium Bonds:
- Savings Goals: Both Cash ISAs and Premium Bonds are suitable for short-term savings goals. Stocks and Shares ISAs offer potential for better returns over the long term.
- Risk and Reward: ISAs and Premium Bonds are low-risk but might not offer high returns. Stocks and Shares ISAs involve higher risk for potentially higher returns.
- Access to Money: Access to funds varies among the accounts, with ISAs offering different levels of liquidity.
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Investing in Both:
- Feasibility: It's permissible to save in both an ISA and Premium Bonds simultaneously.
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Safety Comparison:
- Safety of Funds: Premium Bonds, being government-backed, are considered safe. Cash ISAs also offer low-risk with protections via compensation schemes. However, Stocks and Shares ISAs carry more risk due to market fluctuations.
In summary, the choice between ISAs and Premium Bonds depends on individual financial goals, risk tolerance, and the intended length of investment. While both offer tax-free returns, they differ in terms of potential returns, liquidity, and associated risks, making it crucial for investors to weigh their options based on their specific circ*mstances and preferences.
