Are savings in ISAs or Premium Bonds better for a 5+ year horizon? Many UK residents worry that low headline rates or lottery-style returns will erode purchasing power over several years. This guide focuses only on Long-Term Savings (5+ years) and explains, in plain English, which option suits which goal, how inflation and volatility affect outcomes, and a step-by-step practical strategy to combine both for durable, tax-free real returns.
Key takeaways: what to know in 1 minute
- ISAs usually deliver predictable, compound returns over 5+ years, especially Stocks & Shares ISAs, which historically outperform cash in real terms when held long term.
- Premium Bonds provide capital security but uncertain returns; prizes are tax-free and capital is guaranteed by NS&I, but expected return equals the prize rate (variable) and is probabilistic.
- Inflation matters: for horizons of 5+ years, beating inflation requires at least modest exposure to growth assets or higher fixed rates; cash ISAs often fail to protect purchasing power.
- Diversification works: combining S&S ISAs for growth and Premium Bonds or Cash ISAs for capital preservation reduces tail risk while preserving ISA tax benefits.
- Actionable strategy: decide on expected real return, allocate by goal (capital preservation vs growth), and review yearly — rebalancing keeps long-term odds in your favour.
Interest rates and returns: ISAs versus Premium Bonds
How returns form differs markedly between ISAs and Premium Bonds. A Stocks & Shares ISA produces returns from capital growth and dividends; a Cash ISA produces interest. Both compound in a conventional way and rates or returns are typically visible as annual percentages (CAGR for stocks). Premium Bonds do not pay interest: instead, each bond (worth £1) is entered into monthly prize draws with a stated annual prize fund rate (for example, NS&I may advertise an indicative prize fund rate of around 3.1% at times), but actual realised return follows a lottery distribution.
- Cash ISA: predictable nominal interest, often fixed or variable; suitability: short to medium term but rarely beats inflation over 5+ years.
- Stocks & Shares ISA: variable annual returns; suitable for 5+ years due to volatility smoothing and historical risk premium.
- Premium Bonds: capital guaranteed; expected return equals the prize fund rate but outcomes are skewed — many win nothing, a few win large prizes.
Practical comparison (indicative at time of writing):
| Product |
typical quoted return (nominal) |
volatility |
capital guarantee |
tax treatment |
| Cash ISA (variable) |
1%–4% |
very low |
yes (bank FSCS limits) |
tax-free |
| Fixed-rate Cash ISA (5+ yrs) |
1.5%–4.5% |
very low |
yes |
tax-free |
| Stocks & Shares ISA |
-5% to +20% p.a. historically (wide) |
high |
no |
tax-free on gains/income |
| Premium Bonds |
prize fund rate e.g. ~3% (indicative) |
lottery distribution |
yes (NS&I) |
prize winnings tax-free |
Sources for product rules and rates: gov.uk on ISAs, NS&I Premium Bonds.
Tax-free long-term savings: choosing ISAs or Premium Bonds
Both ISAs and Premium Bonds offer tax-free benefits but in different ways. ISAs provide a wrapper: all interest, dividends and gains inside the ISA are sheltered from UK income tax and capital gains tax. Premium Bonds' prize winnings are tax-free but the product is not a tax wrapper — the capital itself can be held outside an ISA, yet prizes remain tax-free.
Key considerations for 5+ year planning:
- ISA allowance: the 2025/26 annual ISA limit remains indicative at £20,000 per tax year. Using the ISA allowance maximises tax efficiency for long-term growth. See official limit details at gov.uk.
- Using Premium Bonds outside an ISA can be optimal when prize tax treatment is favourable for the saver, but using an ISA for stocks/funds preserves compound growth free of tax.
- For high-income households who would face tax on dividends or capital gains outside an ISA, prioritising ISA allowance for growth assets is usually advisable for 5+ year horizons.
Inflation impact on 5+ year ISAs and Premium Bonds
Inflation erodes real purchasing power. For a 5+ year horizon, the key question is whether nominal returns minus inflation (real return) remain positive. Historical UK CPI inflation averages vary; recent periods experienced higher inflation (2021–2024). Official inflation data is available from the Office for National Statistics at ONS.
- Cash ISAs: if nominal interest is below inflation, real return is negative. Over 5+ years, this often results in loss of purchasing power.
- Fixed-rate ISAs locked at higher rates can protect against inflation temporarily but may lag if inflation spikes unexpectedly.
- Stocks & Shares ISAs: equities historically offer positive real returns over long horizons, helping protect against inflation, though not guaranteed over any single 5-year period.
- Premium Bonds: expected return is the prize fund rate. If the prize fund rate is below inflation, the expected real return is negative despite capital preservation.
Example scenarios for a £10,000 initial investment held 5 years (simplified, illustrative, nominal returns):
- Conservative: Cash ISA 2% p.a., CPI 2.5% → real loss ~ -0.5% p.a.; final value real-term down.
- Expected: S&S ISA 6% p.a. nominal, CPI 2.5% → real ~3.4% p.a.; compounding protective.
- Premium Bonds: prize fund rate 3% (expected) vs CPI 2.5% → expected real ~0.5% p.a., but wide dispersion.
Probability matters: Premium Bonds include a high probability of small or zero nominal gain for many holders and a low probability of big prizes. For inflation protection over 5+ years, exposure to growth assets inside an ISA tends to offer a higher probability of positive real returns.
Risk, volatility and capital growth: ISA compared to Premium Bonds
Risk assessment for a 5+ year saver should separate capital loss risk, return volatility and tail risk.
- Capital loss: Premium Bonds and Cash ISAs offer capital protection (subject to FSCS limits or NS&I backing). Stocks & Shares ISAs expose capital to market falls; however, holding for 5+ years historically reduces, but does not eliminate, the chance of negative cumulative returns.
- Volatility: equities are volatile. Over 5+ years, volatility tends to smooth, improving the chance of positive returns compared with one-year horizons.
- Tail risk: Premium Bonds eliminate downside capital tail risk but substitute it with return uncertainty (lottery distribution). S&S ISAs have downside tail risk during severe market drawdowns.
Quantitative indicators relevant for 5+ years:
- CAGR (compound annual growth rate): best summary for multi-year returns.
- Maximum drawdown: measures depth of worst fall; important if funds may be needed during the period.
- Probability of beating inflation: backtested percentage of multi-year windows where the chosen asset outperformed CPI.
Backtesting gaps in common guides: many comparisons omit probability-of-beating-inflation metrics for 5-year windows. Including these provides actionable insight: historically, a diversified equity portfolio has outperformed UK CPI in >70% of rolling 5-year windows since 1985, whereas Cash instruments often lagged.
Premium bonds prizes versus ISA interest: long-term outlook
Premium Bonds distribute returns via prizes. The prize fund rate is an indicative average return; the actual realised return for an individual depends on luck. Over 5+ years, expected return equals the average prize fund rate, but variance is large.
- Expected return vs variance: for modest holdings (<£10k), the chance of winning frequently is low; expected return remains, but utility for long-term growth is limited by variance.
- For large holdings, the law of large numbers reduces variance and the expected return approaches the prize fund rate; however, holding large sums in Premium Bonds may be sensible for those prioritising capital guarantee and modest expected returns.
Numeric comparison (illustrative): assume prize fund rate 3% and S&S ISA expected nominal return 6% p.a.
- £10,000 in Premium Bonds at 3% expected over 5 years ≈ nominal expected final ~£11,592 (but distribution wide).
- £10,000 in S&S ISA at 6% CAGR over 5 years ≈ £13,382 (higher expected outcome; subject to market risk).
Consider tax: S&S ISA gains are tax-free. Holding equities outside an ISA would incur capital gains tax on realised gains; therefore, using ISA allowance for long-term growth compounds tax advantages.
Practical 5+ year strategy: diversifying ISAs and Premium Bonds
A pragmatic allocation approach for a 5+ year horizon depends on the saver’s objective (capital preservation, growth, or a mix) and risk tolerance.
Suggested starter allocations (indicative; personalised advice recommended):
- Capital preservation focus (e.g. buying a house in 5 years): 70% Cash ISA or fixed-rate ISA or Premium Bonds (capital protection), 30% short-term low-volatility funds in an ISA.
- Balanced objective (preserve capital but seek some growth): 40% Premium Bonds/Cash ISA, 60% Stocks & Shares ISA with diversified index funds.
- Growth focus (retirement beyond 5 years): 80–100% Stocks & Shares ISA (diversified) with emergency fund outside or in Premium Bonds.
Rebalancing and rules:
- Rebalance annually to maintain target allocation.
- Use ISA allowances each tax year to top up growth exposure where possible.
- Consider laddering fixed-rate ISAs or keeping a portion in Premium Bonds to access capital without market timing risk.
Scenario projections: conservative, expected, aggressive
These simplified projections assume a £20,000 one-off investment and no further contributions (illustrative):
- Conservative: 100% Cash/Fixed ISA at 2% p.a. → 5-year value ~£22,082.
- Expected: 60% S&S ISA at 6% and 40% Premium Bonds at 3% blended CAGR ~4.8% → 5-year value ~£25,021.
- Aggressive: 100% S&S ISA at 6% p.a. → 5-year value ~£26,820.
Add contributions and tax sheltering (using annual ISA allowances) to increase long-term effect; using ISA allowance compounds tax advantages.
Comparison: ISAs vs Premium Bonds for 5+ years
ISA (Stocks & Shares)
- ✓Higher long-term expected returns
- ⚠Higher volatility
- ✓Tax-free growth inside ISA
Premium Bonds
- ✓Capital guaranteed by NS&I
- ✗Uncertain individual returns
- ⚠Best for capital safety, not guaranteed inflation-beating
Advantages, risks and common mistakes
Frequently asked questions
Are Premium Bonds safe for a five-year plan?
Yes. Premium Bonds are backed by HM Treasury through NS&I, so capital is secure. However, expected returns are probabilistic and may not beat inflation over five years.
Should a 5-year emergency fund be in an ISA or Premium Bonds?
If immediate access and capital guarantee are essential, Premium Bonds or a Cash ISA are appropriate; use Premium Bonds for capital security and potential upside, but keep expectations modest.
Will a Stocks & Shares ISA likely beat inflation over 5+ years?
Historically, diversified equities have outperformed inflation across many rolling 5-year periods, but there are no guarantees in any given 5-year window.
Can prize winnings from Premium Bonds affect benefits or tax credits?
Premium Bond prizes are tax-free and generally do not count as savings income, but means-tested benefit rules vary. Check guidance and, if needed, speak to a benefits adviser.
How should ISA allowance be prioritised between cash and stocks?
Prioritise Stocks & Shares ISA for long-term growth to use tax-free compounding, and use Cash ISA or Premium Bonds for portions required as stable capital or short-term needs.
What happens if the prize fund rate changes during a five-year period?
NS&I adjusts rates; expected returns change accordingly. Premium Bonds remain capital safe but expected return projections must be updated when prize fund rates change.
Is it sensible to hold both ISAs and Premium Bonds for retirement saving?
Yes. Combining tax-free growth in an ISA with a proportion in Premium Bonds for capital preservation and liquidity balances long-term growth needs and risk tolerance.
Your next step:
- Determine the main objective for the 5+ year pot: preserve capital, grow capital, or both.
- Use the ISA allowance first for growth assets if long-term appreciation is required — prioritise S&S ISAs for the growth portion.
- Allocate a safety portion to Premium Bonds or Cash ISAs for immediate access and capital guarantee; rebalance annually and update projections to current prize fund and interest rates.