Are Premium Bonds Tax Free? The Tax Rules

Premium Bonds are an investment product offered by the United Kingdom’s National Savings and Investments (NS&I). Unlike traditional savings accounts that pay predictable interest, Premium Bonds do not generate interest but instead enter the holder into a monthly prize draw. For each £1 bond held, the owner receives a number with a chance to win tax-free prizes, with amounts ranging from £25 to a £1 million jackpot.

Tax Treatment of Prize Winnings

For residents of the United Kingdom, any winnings from Premium Bonds are free from UK Income Tax and Capital Gains Tax. The prizes are not classified as interest income and do not count towards an individual’s Personal Savings Allowance, which is the amount of interest a person can earn from standard savings accounts before tax is due.

Because the prizes are exempt, there is no requirement for a UK taxpayer to declare any Premium Bond winnings on their annual Self Assessment tax return. This applies regardless of the prize size. The funds are paid out as a lump sum without any tax deducted at the source.

Inheritance Tax Considerations

While the prizes from Premium Bonds are free from income tax, the bonds themselves are not exempt from UK Inheritance Tax (IHT). Upon the death of the bondholder, the total value of their Premium Bonds is considered part of their estate. This value is aggregated with all other assets to determine the total value of the deceased’s estate.

This total figure is then assessed against the current IHT threshold, often referred to as the nil-rate band. If the estate’s total value, including the Premium Bonds, exceeds this threshold, the excess amount may be subject to IHT at the prevailing rate. The bonds contribute to the overall value, and therefore can impact whether an estate is liable for tax. Executors of an estate must ensure they accurately value and report the deceased’s Premium Bond holdings as part of the probate process.

Tax Rules for Non-UK Residents

The tax treatment of Premium Bond prizes differs for individuals who are not residents of the UK. While the winnings are exempt from any UK taxes, they may be considered taxable income in the bondholder’s country of residence. It is the responsibility of the non-resident holder to comply with the tax laws of their specific jurisdiction.

For United States citizens, this is a particularly important consideration. The Internal Revenue Service (IRS) generally taxes the worldwide income of its citizens, which includes prizes and gambling winnings from foreign sources. Therefore, a US citizen who wins a prize from Premium Bonds would likely need to report this as “Other Income” on their Form 1040 tax return. Given the complexities of international tax law, US holders of Premium Bonds are often advised to seek professional tax advice to ensure they meet all their reporting obligations and determine the correct tax treatment for any prizes received.