Putting money aside now for your retirement might not the first thing that springs to mind, especially for younger investors. But, unlike many things, pensions typically get better with age – the earlier you start, the bigger the pot. So, make sure you maximise the time advantage.
From 6th April this year, if you’re one of the nine million workers who have an auto-enrolment pension, you will have to pay more in. Your monthly contributions could be about to triple, from a minimum of 1% of your salary to a minimum of 3% of your salary. This could see you paying several hundred pounds a year more into your workplace pension. If you’re thinking you’re not sure if it’s the right thing for you to do – it’s worth noting that you will also receive a 2% contribution boost from your employer and tax relief from the government. So, now is a good time to think about your retirement.
Visualising your retirement can be difficult, not least because it can feel so far away. Many of us may plan to work much later in life than the generations before us, and for others the idea of an early retirement may be very appealing. But almost all of us imagine a retirement that is comfortable, safe and secure, where we can enjoy our later life without having to worry about finances.
Yet research conducted by the FCA, showed that only 58% of adults between 55 and 64 were happy with their pension choices1, while 36% of UK adults between 18 and 44 did not have a private pension provision2 and will be reliant only on the state pension.
But no matter what stage of life you are at, investors and savers shouldn’t ignore the benefits that time can provide in helping them save towards retirement.
A small sacrifice now, for a larger benefit later
We’ve looked at a number of examples to demonstrate just how important time is to maximising your retirement. For each example, we’ve assumed a starting pot of £5,000, and contributions in-line with the average UK adult, approximately £1,090 per year (£91 per month)3. We’ve also assumed inflation of 2.5% and capital growth of 5% per annum after fees.
The table below shows the expected retirement values for individuals of different ages if they started to save for their retirement immediately, or alternatively waited five more years. The results may surprise you:
For a 30 year old, the difference between starting immediately or waiting five years to start saving could be a staggering £31,504 at retirement! Given the average UK pension pot of £49,9884, that’s a significant boost to your pension savings. And while this includes the value of contributions for the additional years, the value of the first five years contributions is just £5,683.
But it’s not just younger generations that can benefit for the time advantage. If you’re 40, starting now could net you an extra £19,531 versus if you waited five years, while a 50 year old would benefit from an extra £12,190 by starting now.
The power of compound returns
How does such a small difference in savings period account for such a large difference in pension pots? The answer is that the pots returns are magnified by the effect of compound interest. Compound interest is the concept of applying interest (or in this case, investment returns) to both the principal and the returns previously generated.
For example, a £1,000 portfolio returns 5% over a 12 month period. The portfolio is now worth £1,050, meaning the gain in year one is £50. If the portfolio grows another 5% in the next 12 months (£1050 x 1.05%) the gain is now £52.50, and the portfolio is now valued at £1102.50. The gains continue to grow incrementally as you earn a return not just on your original investment, but also on your returns.
Don’t forget about the impact of costs
The negative impact of high costs and charges on pension pots has been often talked about in the media and is one of the reasons the Financial Conduct Authority introduced a 0.75% cap on auto-enrolment funds. Keeping costs under control is another way of maximising your investment outcomes. Remember: what isn’t taken in costs, you get to keep, meaning the lower the fees the higher the returns in your portfolio.
And even better, the effect of these savings will also be enhanced by compound interest over the long term, meaning the cost savings can be very significant over time.
Near or Far, time is on your side
Whether you’re ten years or thirty years from retirement, getting a head start can significantly improve the value of your pension pot. What’s more, getting to grips with your retirement plans doesn’t need to be time consuming or confusing.
Nutmeg have a range of tools to help you, such as our pensions calculator, that can help you understand how much you need to save for your own circumstances. If you have multiple pensions, you can consolidate them in order to better understand and keep track of your retirement, and we can even arrange for your employer to contribute directly to your Nutmeg pension on your behalf. You could also receive a 25% instant top up to new contributions (subject to eligibility).
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Pension rules apply and tax rules may change in future. If you need help with pensions, seek independent financial advice.
[This article was first published in Your Money, 24 April 2018]
- We’ve used the weighted average total contribution rate to defined contribution schemes in 2016 (4.2%), applied to the average UK salary in Dec 2016 (£25,896, based on average weekly earnings of £498). https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/pensionssavingsandinvestments/bulletins/occupationalpensionschemessurvey/uk2016#contribution-rates-in-private-sector-occupational-pension-schemes