Grandparents often want to spoil their grandchildren. It is a natural reaction to want to shower a new grandchild with gifts and experiences. Another common want from grandparents is to be able to give their grandchildren money so they can become savers before they're born. As a result, grandparents often look at various saving options to transfer some of their wealth. Premium Bonds are one such option and have been popular in the past. But is that popularity a true reflection of the quality of the product?
What is a Premium Bond?
Premium Bonds are a particular, unique type of bond. However, while traditional-style bondholders receive a return linked to the bond's interest rate, Premium Bonds don't pay a regular, agreed-upon coupon payment each month. Instead, bondholders go into a monthly prize draw for every month they hold a Premium Bond.
You can buy Premium Bonds from NS&I (National Savings and Investments) with as little as £25, with prize amounts starting at £25 and going up to a jackpot of £1 million. NS&I's prize checker informs customers of the number of winners per prize amount each month. Not surprisingly, the £1 million prize draw is won by the fewest number of people, currently two people per month. In contrast, over three million win the lowest £25 prize. That may sound like many winners, but the chances of winning even £25 are small.
Prizes are all tax-free, so they can provide the opportunity to win a lot of money if you're lucky enough to have your unique account number picked in the prize draw. It is almost like buying a lottery ticket. The difference is that you can sell your Premium Bond at any time and get back your initial investment.
Advantages of Premium Bonds for grandchildren
You may have already identified one glaring advantage of buying Premium Bonds for your grandchildren. With just a small investment, there is a chance that they could become a millionaire if their bond number is drawn. This can occur even on the first time that a bondholder's number is eligible to be picked. As a result, the interest rate you could potentially earn from buying Premium Bonds for your grandchild can be exceptionally high. Much higher than a traditional bond or from conventional savings accounts.
Other advantages of Premium Bonds are that they are free of capital gains tax, unlike other gains from most investment accounts. If you're looking at ways to reduce inheritance tax, however, it is still prudent to talk to a tax advisor who will be able to fully explain to you the implications of buying Premium Bonds for your grandchildren in this tax year and perhaps even beyond.
One advantage that many grandparents like about Premium Bonds for their grandchildren is that they are relatively easy to buy. Grandparents (or even family friends) find that many products can be challenging to open for people other than themselves or their own child. With Premium Bonds, the company makes it possible to name a nominated parent or legal guardian on the application form. As a result, those individuals can look after the account on behalf of the child, but the grandparent does all the initial leg work.
Disadvantages of Premium Bonds for grandchildren
Sadly, the disadvantages of buying Premium Bonds for your grandchildren are plentiful. While, in theory, it is a great thing to do, the prize fund rate is so low that you are usually better off investing your cash elsewhere. Yes, your grandchild could win £1 million if their unique bond number is drawn. But the likelihood of even winning the lowest prize of £25 is small. As a result, with the impact of inflation, not only is your money not earning any interest as it would in another bank account, it is losing value, too.
Plus, its tax-free advantage is not as powerful as it once was. For several years now, the Government has implemented a personal savings allowance (PSA), which means that most of a person's interest in savings is tax-free anyway. The personal savings allowance starts at £1,000 for those in the 20% income tax rate, going down to £500 for higher rate taxpayers. Those paying 45% on their income do not receive a PSA. However, the impact is that basic and higher rate taxpayers rarely pay tax on their savings. Hence, the tax-free benefit of Premium Bonds is close to null and void.
Other options for saving for your grandchildren
Given the disadvantages of buying Premium Bonds for your grandchildren, you may want to consider these other options:
A junior ISA can either be a cash ISA or a stocks and shares ISA. These are also tax-free earning accounts. Cash ISAs will earn a certain interest rate each year, which the bank will have advertised at account opening. Stocks and Shares ISAs are products where account holders can purchase different stocks and shares. All gains remain tax-free, which can be a significant money-saving.
There are numerous savings accounts on the market which can offer a person the chance to earn interest on what is held within the account. Savings accounts at bank accounts do not have very high interest rates right now as the Bank of England base rate remains low. However, it is starting to increase, so savings accounts could begin paying a little more than they have done for years. You can open a savings account at banks or building societies.
One means of saving for your grandchildren not often discussed is to purchase alternative assets for them. The technicality of who 'holds' them (i.e. whether they are in your name or theirs) will depend on the asset in question. For example, you could buy them jewellery and gift it to them. However, alternative assets like property are more complex for transferring named ownership. However, these investments can help beat inflation and sometimes have discernible uses when your grandchild comes of age.
Premium Bonds for grandchildren
It is a very kind thing to do to put money aside for grandchildren. Plus, it can help reduce your inheritance tax bill when you pass away. However, Premium Bonds can be seen as a loss-making investment, given how they do not earn you any interest (unless you are improbably lucky to win a prize) and how inflation is rising at a fast rate. As a result, well-meaning grandparents may find it more worthwhile to investigate other savings types to help build a nest egg for their grandchildren.