Your savings can lose spending power in either product when inflation is higher than the return. A Cash ISA offers fixed or variable tax-free interest, while Premium Bonds offer tax-free prizes but no guaranteed monthly gain.
Cash ISA rates and inflation: the test that matters
A Cash ISA protects spending power only when its tax-free interest rate exceeds inflation over the same period.
Work out the return after rising prices
A quick estimate is real return = return after tax minus inflation. If an ISA pays 3.50% and CPI is 3.00%, the estimated real return is about +0.50%; £10,000 becomes £10,350 while equivalent goods rise to about £10,300. If the ISA pays 2.50% and CPI is 3.50%, your capital is safe but its buying power falls.
Tax-free does not always mean highest return
Cash ISA interest and Premium Bonds prizes are tax-free, so tax does not usually decide between them. However, the Personal Savings Allowance means some ordinary savings interest can also be tax-free: typically £1,000 for basic-rate taxpayers, £500 for higher-rate taxpayers and £0 for additional-rate taxpayers. Compare the after-tax rate, not the label.
Safety is separate from the return
Premium Bonds are backed by HM Treasury through NS&I. Eligible Cash ISA deposits with authorised banks and building societies are generally protected by the Financial Services Compensation Scheme up to the applicable limit. Neither protection prevents inflation from reducing buying power.
For cash needed on a known date, compare the ISA rate with CPI and choose the account only if you can accept its access terms. A guaranteed 3.50% tax-free return is easier to plan around than a prize outcome which could be 0%.
Choose this if: choose a Cash ISA if you need a predictable balance and the best chance of keeping pace with inflation.
When comparing cash savings rates, separate the headline rate from the inflation-adjusted return. A Cash ISA is a tax-free savings account, so its stated interest is normally the return you keep; this makes a guaranteed savings return easier to compare with CPI. For example, a 4.00% Cash ISA rate with 3.20% Consumer Prices Index (CPI) inflation gives an approximate real return of +0.80%. Premium Bonds have no equivalent guaranteed rate: their prize fund rate is an average across holders, while an individual’s return may be zero.
This savings inflation risk matters most where the money has a fixed purpose and date, because a nominal gain does not automatically preserve purchasing power.
Compare no-prize, average and high-prize outcomes
Premium Bonds can beat a Cash ISA for one person, but their prize fund rate is not a guaranteed interest rate.
The table is a worked example: £10,000 for 12 months, CPI inflation of 3.00%, and a Cash ISA paying 3.50%. Check live rates before acting.
| £10,000 for 12 months | Return before inflation | Value after 3.00% CPI | Decision meaning |
|---|
| Cash ISA at 3.50% | £350 guaranteed, tax-free | About +0.50% real return | Known gain in spending power |
| Premium Bonds, no prize | £0 | About -3.00% real return | Balance stays £10,000 but buys less |
| Premium Bonds, £350 prizes | £350 tax-free | About +0.50% real return | Matches this ISA example |
| Premium Bonds, £1,000 prize | £1,000 tax-free | About +7.00% real return | Excellent outcome, but not plannable |
A £1,000 prize produces an excellent real return, but it is an outcome rather than a plan.
The prize fund rate is an average
The Premium Bonds prize fund rate is the value NS&I expects to distribute across all eligible bonds, not a return promised on your holding. Your £10,000 could win nothing, receive prizes near the average, or win far more. Check current figures on NS&I.
Match dates before you compare
Compare an ISA return and inflation over the same 12 months. A fixed-rate ISA gives a known rate but may charge an interest penalty for early withdrawal; Premium Bonds have no fixed return. If a no-prize year would be unacceptable, use the Cash ISA.
Choose this if: choose Premium Bonds only if you can accept a 0% year and value the chance of a larger prize.
Choose by when you need the money
A short- or medium-term goal normally favours a Cash ISA because a dated purchase needs a known balance.
Emergency cash needs quick, known access
An easy-access Cash ISA can suit emergency money if withdrawals are allowed without a fee, although some accounts restrict withdrawals or cut the rate. Premium Bonds can normally be cashed in, but withdrawals may take three to five working days and new bonds usually need one full calendar month before their first eligible draw.
One to five years needs a target amount
For a deposit, wedding or planned car purchase, write down the required amount and date, then choose the account most likely to reach it after inflation. For goals beyond five years, a Stocks and Shares ISA may offer greater growth potential, but investments can fall and are unsuitable for money needed on a fixed date.
This comparison is less useful when you are investing for a long period and can accept market risk, or when immediate access matters and neither product’s timing rules fit. It is not personal financial advice where tax, benefit entitlement or large balances are involved.
Choose this if: choose an easy-access or fixed Cash ISA for a goal with a date; avoid Premium Bonds if no prizes would delay it.
Questions & answers
Can I lose money in Premium Bonds?
You do not lose the face value when cashing in, but you can lose spending power. If inflation is 3% and you win no prizes, the real return is about -3%.
Are Premium Bonds better than a Cash ISA?
Only if your prizes beat the Cash ISA return after inflation. A Cash ISA is usually better for a planned goal because its interest is known.
Do I pay tax on Premium Bonds prizes?
No. Premium Bonds prizes are tax-free, and Cash ISA interest is also tax-free.
Is Cash ISA interest always tax-free?
Yes, interest inside a valid Cash ISA is free from income tax. You must remain within the annual ISA allowance.
Should I use my ISA allowance before Premium Bonds?
Usually, if you want guaranteed tax-free interest and the rate is competitive. Check your Personal Savings Allowance first.
How soon can new Premium Bonds win a prize?
New bonds usually need at least one full calendar month before entering a prize draw. This can matter for bills due within a few months.
What if neither option beats inflation?
Keep enough accessible cash for safety, then consider whether longer-term investing suits your risk tolerance and time frame. Do not invest money needed within five years merely to chase returns.
For most people saving for a known expense, a competitive Cash ISA with suitable access rules is the clearer choice. Premium Bonds can be a reasonable side option for money you can leave alone and can afford to earn nothing.
