There are lots of exciting things to spend your money on when you’re young. Your pension should be one of them, writes Rachel Lacey.
If you’re in your 20s and just starting out in your career, possibly even your 30s, there’s a good chance that your retirement savings are not front of mind.
Buying your own home might still be a pipe dream, or even if you have hit that particular milestone, rising interest rates and cost-of-living challenges might mean your pension still isn’t a priority.
Even if you’re well aware that you need to save more for retirement, you might have parked it as something to think about when you’re on a bigger salary with more cash to spare.
But, the sooner you can start thinking about your pension the better.
While your eventual retirement income does clearly depend on the amount of money you save, if you park your pension until you’re older and better off, you’ll miss out on the pensions secret weapon – time.
The more time you have, the less money you’ll need to find.
Why it pays to save when you’re young
Let’s take the example of a 25-year-old earning £30,000 a year.
Each month they pay 5% of their qualifying earnings into a pension, along with 3% that their employer pays (the statutory minimum for workplace schemes). This means they have a total of £158.40 going into their pension each month (including tax relief from the government.)
By the time they reach state pension age – in this case 68 – they’ll have paid in £127,670 and have a pot worth £387, 216 (assuming 5% investment growth and a 2% increase to contributions each year).
However, if our saver only started saving when they were older and on a bigger salary, they’d have to invest a lot more to achieve the same pension.
Let’s say they started saving once they’d turned 40 with a £45,000 salary and, again, pays in a total of 8%. Although they would be paying more money in - £258.40 a month (investing a total of £114,893) they’d only end up with £234,434 in their pot, over £150,000 less. Even if they’d doubled their personal contributions to 10% (creating a total contribution of 13%), they’d still only get £380,948.
These examples are, admittedly, somewhat artificial. They rely on a lot of assumptions and, in reality few workers would now delay starting saving in a pension, because auto-enrolment signs them up as they become eligible. Nonetheless, they still provide a useful way of highlighting the impact time has on your investment returns.
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In each case there isn’t an enormous difference in the amounts our savers contributed to their pensions. The reason our first saver ends up so much better off, is that their money has 43 years to grow, compared to only 28 for our second.
This is thanks to compound returns – famously described by Einstein as the eighth wonder of the world - and it occurs when the returns your money makes start working for you and earning returns too. Think of it like a snowball getting bigger as it rolls down a mountain, gathering snow. The longer you leave your money invested, the more time it has to reap the benefits of compound returns and the less of your money you’ll need to pay in.
How can I pay any more into my pension?
Like anyone, you’ve probably got a never-ending list of calls on your cash and any number of things you’re saving for.
But increasing your pension contributions doesn’t necessarily mean you have to park other financial goals you might have, or mean your lifestyle needs to take a hit. While you’re still young, even the smallest of increases can make a tangible difference to your eventual retirement pot.
Going back to our 25-year-old saver on £30,000 a year, increasing their contribution by 1% to 6% would cost less than £20 a month and add more than £48,000 to their pension, taking it to £435,581 by the time they’re 68. If they could increase their contribution to 7.5% (costing less than £50 a month more), they could end up with £508,192.
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Another point to mention is tax relief. This effectively means that you don’t pay tax on earnings that you pay into your pension, boosting a basic rate taxpayer’s contribution by 25%. So, the more you can squeeze into your pension, the more you’ll get in government top ups too.
And, if you’re lucky, your employer might match your contributions, meaning if you pay in more, your employer will too.
So while your increase might end up being a bit of a challenge in the short term, the long-term benefits as well as further top ups from the government and maybe your employer, might make you more willing to make the sacrifice.
What if I can’t pay any more in?
Even if you can’t afford to pay any more money in now, there’s still plenty you can do to put you in stead for a better retirement.
In many cases simply taking more of an interest in your pension, understanding how yours works and managing it better can go a long way in increasing its value and spur you on to pay more in when you can afford it.
Start by asking your employer the following:
- What is my pension contribution each month? Find out what percentage of your earnings you and your employer are paying in. It’s also worth checking if they’ll match any increases to your pension contributions for future reference.
- Are my contributions based on my whole salary or just qualifying earnings? Auto-enrolment rules mean employers only need to base your contributions on your qualifying earnings, not your total salary. This is the range of earnings between £6,240 and £50,270. This means that once your earnings exceed that threshold, payments into your pension won’t increase and so the more you earn, the lower the proportion of your earnings your contributions are based on. Some employers will base pension contributions on your whole salary, but they aren’t required to do so by law.
- Is my pension a ‘net pay’ or ‘relief at source’ arrangement? This refers to how tax relief is applied to your pension contributions. If it’s a net pay arrangement your pension contribution will be paid before tax is deducted so you’ll automatically get the right level of tax relief for you. However, if it’s a relief at source scheme, payments will be made after tax has been deducted. Your pension provider will automatically claim basic rate tax relief back for you but, if you pay a higher rate of income tax, you’ll need to claim the additional relief you’re entitled to through a self-assessment tax return.
- Where is my pension invested? Chances are your money is invested in your scheme’s default fund. This is likely to be a one-size fits all fund and while it’s not necessarily a bad fund, it might be on the cautious side. If you’re young and have time to ride out a bit more stock market volatility, you might want to consider investing in a slightly more adventurous fund with the potential for better returns.
If you’re a bit further into your career – and have a number of workplace pensions already – you might also want to consider consolidating those you’re no longer contributing to into a personal pension such as SIPP. In addition to giving you better investment choice, it can also make your retirement savings easier to manage and reduce your costs.
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