But what’s the long term effect of losing those early year contributions?
In your 20s and 30s, retirement age seems a long way off. A house purchase, holidays in the sun and maybe even school fees all take priority over family finances and personal pension planning can easily get pushed to the bottom of the pile.
But if you’ve ever dreamt of retiring early to travel the world and live the life of your dreams, or even if you’d just like to be able to retire when you want and have a comfortable standard of living, it’s time to wake up. Because unless you act now, it’s not going to happen.
Will you be able to afford your dreams?
A 2016 survey by Old Mutual Wealth revealed some worrying trends and statistics. For a start, the average UK retirement income was just £18,000? Clearly, if you’re planning on anything much above subsistence level, that isn’t going to get you far and there remains a significant gap between what people expect their retirement income will be and what it actually is.
What’s more, the Old Mutual Wealth report also found one in three of retirees were also currently in debt, with the average debt being £34,000 (£67,000 in London) and mortgages and credit cards being the most common debts of all. It makes for a gloomy financial situation and if you think that won’t happen to you, well so did one in five of those who took part in the survey.
A shift in the pension landscape and trends
Defined contribution schemes are becoming more prevalent (taking over from the now hard to find final salary). Auto Enrolment may have seen 9 million people starting to make contributions to a defined contribution scheme, but contribution levels remain low and won’t come close to making up for the loss of the benefits enjoyed by final salary schemes.
You can safely assume that your state pension isn’t going to come close to funding your lifestyle either, and defined contribution schemes rely on your investment to grow. Combined with increased longevity, that means investing early and for the long haul.
You might not know when you want to retire but…
Only 15% of those surveyed in the Old Mutual Wealth survey retired at state retirement age (a reduction from 19% in 2015) with the rest continuing to work well after retirement age, a significant proportion of whom were doing so to part fund their retirement. The reality of that is that there’s a big chance of having to say goodbye to any dreams you have of jacking it in at 40, 50, 60 or even 70!
How much will you need in your fund?
As a starting point, take a young couple earning between them a modest £50,000. They’ll need to allow for a pension of roughly two thirds of their final salaries. That means securing a pension fund of £300,000 to £600,000. Realistically, you’ll probably need to save a great deal more than that.
The real cost of lost contributions
You may not have much disposable income now but it’s worth taking a look at these comparisons to see the real impact of not making even a small contribution in the early years.
If you invest just £50 month (not enough but let’s start small) in your 20s with average interest rates of 4%, you’ll have a pension fund of roughly £60,000 at 60. But, if you don’t start investing in your pension until you’re in your 40s but then invest £100 / month, your pension savings will only be £36,500 (applying the same 4% interest rate and assuming the same fund). And that is despite the fact that in either situation, the same amount of money has been invested but over a different period of time (it’s the effects of compound interest).
Compound interest (in effect interest on interest) on pension investments makes it particularly worthwhile for you to start saving as early as possible and for every year you put off investing now, you’ll have to fork out even more later in life.
And then there’s the tax relief
Despite all the bad press over recent years, pensions remain an extremely tax efficient method of saving. Pension payments attract what is in effect a government top up as the government repays your tax at the highest rate you normally pay.
If you’re paying your £50 monthly contribution, the actual payment into your pension account will be £62.50 (for a basic rate taxpayer paying tax at 20%). For those paying at 40% tax, of course, a contribution of £100 increases to £166. And you can top up any defined workplace pension by paying into a personal pension in addition.
Start early and enjoy later life
A pension is a sensible, tax efficient and essential long-term savings plan. Your contributions will continue to grow throughout your working career but without an early start, you may well find, that later life is not what you dreamed it would be.
With some careful budgeting and some tax planning, it should be possible to find the funds to start your contributions now, so don’t put it off until next year or worse still, next decade!