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Why a five-year head start on pension savings can make a real difference

Written by: James McManus
Putting money aside now for your retirement might not be 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.

If you’re one of the nine million workers who have an auto-enrolment pension, you could see contributions triple from a minimum of 1% of your salary to a minimum of 3% of your salary.

This means you could pay £100s a year more into your workplace pension. If you’re wondering whether this is the right thing for you, it’s worth noting you’ll also receive a 2% contribution from your employer, as well as tax relief from the government.

Visualising your retirement can be difficult, not least because it can feel so far away. 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.

No matter what stage of life you are at, investors and savers shouldn’t ignore the benefits that time can provide in helping to save towards retirement.

A small sacrifice now, for a larger benefit later

We 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). 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:


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 is £49,988, 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 who can benefit from 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 (£1,050 x 1.05%) the gain is now £52.50, and the portfolio is now valued at £1,102.50. 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 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.

James McManus is investment manager at Nutmeg

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