Premium bonds have been around since 1956 and are the most popular savings product in the UK. Almost half the population has money invested in them (over £40 billion in 2008) and you can win between £25 and £1 million tax free. The attractions are obvious - every month there is a prize draw and each £1 bond you buy stands a chance of winning you a fortune until such time as you redeem it. You can hold bonds worth up to £30,000 and that money is completely safe as it is backed by the UK Treasury - there is no chance of losing it.
However, you have to take into consideration the fact that no interest is paid on Premium Bonds, just prize money. Also, the amount of prize money each month is determined by an interest rate, which at the time of writing is only 1%. It tends to go up and down with the Bank of England base rate, so at present total prize money is very low. Each month there is usually one prize of £1 million and about a million prizes of £25 each, 20,000 of £50 each and about 3,000 prizes of £500 or more. It doesn't take a genius to work out that your chances of winning the top prizes are fairly remote - divide 40 billion by 3,000 and that will give you some idea. In fact, according to one source, you are three thousand times more likely to win £1 million on the National Lottery than you are from buying Premium Bonds, although of course you do get your money back with Premium Bonds.
If you compare the average winnings from say 100 Premium Bonds with interest from a Cash ISA over a year, the ISA will earn about £3.60 for every £1 you would win on the bonds. Even a higher-rate taxpayer with a non-ISA account would earn about £2.10 net of tax according to the popular website MoneySavingExpert.com. So from an investment point of view, there are obviously much better places to put your cash.
Why do we mention them at all on a tax website? Well if half the population has put money in them they are obviously very popular and therefore worthy of some comment. And if you really want to win a million pounds for a £1 stake, you are not going to do so by putting it in the bank, or even by buying penny shares in the world's next Microsoft. And that's probably the best way to look at Premium Bonds - as a free shot at winning a million pounds each month. All you stand to lose is the miserly rate of interest you would have earned in a bank account.
Of course, it has to be said that Premium Bonds are very tax efficient - you don't have to share your winnings with the taxman - but then again so is the National Lottery, unless you think of it as a voluntary tax!
One further point - they are only valid for a year after the holder dies, so if someone has died recently leaving you Premium Bonds, you'd better cash them in quick.