What is a Lottery Bond
A lottery bond is a type of government bond, most famously issued by the United Kingdom's National Savings and Investment (NS&I). It gives the holder a chance to win a random monthly drawing for a tax-free cash prize. The bonds do not pay interest, but they do encourage saving. However, like zero-coupon bonds, they do not pay interest and are not protected against inflation. Otherwise, these are considered extremely safe because they are backed by the U.K. government. The bonds can be purchased directly from NS&I or from the post office. Each bond is worth £1 and there is a £100 minimum investment.
A lottery bond also refers to a type of commercial surety bond which establishments with lottery machines must purchase to prevent abuse of the state lottery system.
BREAKING DOWN Lottery Bond
The U.K.'s lottery bonds, introduced in 1956, have the goal of reducing inflation and attracting people who were otherwise not interested in saving. The bonds are officially referred to as premium bonds. These bonds are not legal for sale in the United States.
In 2008, £40 billion was invested in premium bonds and were one of the country's most popular savings vehicles. A machine called ERNIE randomly generates the winning bond numbers. The amount of the prize fund is one month's interest on all eligible bonds. Multiple winners receive prizes of varying amounts from the fund.
Global Use of Lottery Bonds
Lottery bonds saw wide use during the nineteenth century. They were issued by states and municipalities or issued by companies like the Panama Canal Company and the Suez Canal Company and received state backing.
Lottery bonds also find use in countries outside the United Kingdom. After the British government had success using them as a means to promote savings, other countries followed suit. New Zealand issued its lottery bond, called Bonus Bonds, in 1970.
When New Zealanders buy bonus bonds, their money is pooled with other bondholders and invested into fixed interest assets and cash equivalents. The interest earned on these investment products is the basis for funding the prizes which are awarded. Funds also maintain the principal investment value of the non-winners bonus bonds. In 2017, the average monthly prize amount was $4,109. There is an average of 134,942 winners each month out of 3,373,920,421 eligible bonus bondholders.
Swedish lottery bonds saw a use for many years as a means of tax arbitrage by wealthy investors. An investor with a capital gain from the stock market will purchase lottery bonds before the lottery drawing. They will then sell those bonds at a lost after the lottery is over. Tax-free proceeds from the bond lottery cover the lost revenue. Popular in the 1970s and 1980s, the strategy was ended as Sweden reformed its tax laws in 1991.