Millions of Premium Bond customers who daydream about winning big are facing a reality check as their chances of landing a cash prize are about to get slimmer.

Premium Bonds offer some of the excitement of a flutter on the horses for the risk-averse. The government-backed savings products are tax-free, 100 per cent secure because they are backed by the Treasury and, unlike many savings accounts, you can take your money out when you like without a penalty. For their 22 million customers, it is hard to put a price on the possibility, however distant it might be, of winning the £1 million jackpot and being able to pay off the mortgage or even give up work. If you have ever owned bonds you are probably familiar with the thrill of recognising the envelope on your doormat and anticipating whether it will contain a cheque for £25 or news that you have won a life-changing sum. For this reason, many are willing to forgo any return at all on their savings during the months or even years that they do not win prizes. For those savers, the barren periods in between winnings are about to get longer.

The odds are lengthening

NS&I is cutting the total monthly prize fund by nearly 14 per cent from £57.1 million to £49.3 million on August 1. There will still be a million-pound winner every month, but the number of people in the other prize categories will be cut. Instead of 1.9 million monthly cash winners, there will be 1.75 million.

The number of £100,000 prizes awarded each month will fall from five to three, £50,000 prizes will drop from nine to six and £25,000 prizes will almost halve from 20 to 11. There will also be reductions across all the other prize categories, which start at £25.

These reductions mean that for every £1 invested in premium bonds (the minimum you can buy is £100) the odds of winning one of the cash prizes are lengthening from 1 in 24,000 to 1 in 26,000. The effective interest rate, which is calculated based on the average winnings relative to the sum invested, is reducing from 1.5 per cent to 1.3 per cent.

NS&I says that it had no choice but to cut the prize fund because otherwise it stood to breach its Treasury-set target of net sales of zero in the year to March 2014 (with a range of £2 billion either side). The state savings organisation has already made a net £1.7 billion of product sales in the first quarter driven by the poor returns on bank and building society accounts. NS&I once sponsored the Classic Brit Awards but this kind of marketing would now risk attracting far too much business and pushing it even further over its limits.

The cuts to the Premium Bond prize fund come on top of another blow to savers as NS&I has previously announced that it will be reducing the interest rates on three popular savings products from September 13. The rates on its Direct Isa are falling from 2.25 per cent to 1.75 per cent, its Direct Saver from 1.5 per cent to 1.1 per cent and its Income Bond from 1.75 per cent to 1.25 per cent in a move that will affect almost 590,000 customers.

Does saving into Premium Bonds still make sense?

Even after the reduction in August, the effective interest rate of 1.3 per cent is double the rate of an average easy-access savings account at 0.7 per cent, according to Moneyfacts.co.uk, the comparison website. Of course you could be unlucky and not win anything. You should fill up your tax-free cash Isa allowance before spending your savings on bonds. Nationwide Building Society has a best-buy Easy Saver Isa (Issue 2) which pays 2 per cent, but you can only save up to £5,760, which is the annual allowance for cash Isas this year. The rate drops to 0.5 per cent in November 2014, so you would need to move your money at that point and you cannot transfer in existing balances. It also offers the Flexclusive Isa to its current-account customers, which pays a higher rate of 2.25 per cent. Cheshire Building Society’s Isa Saver (Issue 4) pays a variable rate of 1.7 per cent until January 2015. It allows transfers in, and there is no maximum investment.

Once you have used up your cash Isa allowance, Premium Bonds start to look more attractive because they are also tax-free and you can invest up to £30,000. The typical return you get is equivalent to a higher rate of interest than that of an ordinary taxable savings account. For a basic-rate taxpayer, the effective interest rate from August is equivalent to a return of 1.625 per cent, for a higher-rate taxpayer it is 2.17 per cent and for a 45 per cent taxpayer it is 2.36 per cent.

ICICI Bank’s HiSAVE SuperSavings Online Account is the best-buy easy-access savings account with a rate of 1.75 per cent, which means it pays more than the NS&I products for basic-rate taxpayers, but those who pay 40 per cent tax or more may be better off with Premium Bonds.

Patrick Connolly, of Chase de Vere, the independent financial adviser, says typical returns on Premium Bonds “remain very competitive” for higher and additional rate taxpayers, but customers should not forget that if they win nothing their savings pot would be eroded by inflation.