What Is a Lottery Bond?

A lottery bond is a government bond most famously issued by the United Kingdom's National Savings and Investments (NS&I). The bond 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 are not protected against inflation. Otherwise, these are considered extremely safe because they are backed by the U.K. government.

Key Takeaways:

  • A lottery bond is a government bond that gives the holder a chance to win a random monthly drawing for a tax-free cash prize.
  • In the United Kingdom, lottery bonds are called premium bonds.
  • The bonds do not pay interest, but they do encourage saving and, in the United Kingdom, the bonds are backed by the U.K. government.
  • Each bond is worth £1, and there is a £25 minimum investment and a £50,000 maximum investment.

How Lottery Bonds Work

The U.K.'s lottery bonds, introduced in 1956, aim to reduce inflation and attract people who are 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. The bonds can be purchased directly from NS&I or from the post office. Each bond is worth £1, and there is a £25 minimum investment.

A lottery bond also refers to a type of commercial surety bond that establishments with lottery machines must purchase to prevent abuse of the state lottery system.

As of April 2019, over £80 billion had been invested in U.K. premium bonds. 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. In September 2020, the monthly prize amount totaled £110,000, and there were around 308 million total prizes.

Global Use of Lottery Bonds

Lottery bonds saw wide use during the 19th century. They were issued by states and municipalities or issued by companies like the Panama Canal Company and the Suez Canal Company with state backing.

Lottery bonds are also found 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 in fixed interest assets and cash equivalents. The interest earned on these investment products is the basis for funding the prizes awarded to winners. The funds also maintain the principal investment value of the non-winners bonus bonds.

Real-World Example of Lottery Bonds

Swedish lottery bonds saw lottery bonds as a means of tax arbitrage by wealthy investors for many years. 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 loss after the lottery is over. Tax-free proceeds from the lottery cover the lost revenue. Popular in the 1970s and 1980s, the strategy ended in 1991 when Sweden reformed its tax laws.