Would it actually make any difference to my retirement if I added another one per cent to my pension contributions – or should I just enjoy it now?
Upping contributions: How does the age you start saving and the amount you pay in each month affect your pension pot?
William Burrows, retirement director at specialist adviser Better Retirement Group, replies: The quick answer to this question is ‘yes’.
If you increase your pension contributions by just 1 per cent, for instance from 3 per cent of your salary each year to 4 per cent, you can expect to have a 33 per cent bigger pension pot by the time you retire.
We’ve put together a table to show what a difference paying in an extra one per cent can make.
Of course the amount you will have saved up in your pension pot depends on many factors including the age you start saving and the amount you pay in each month, so we’ve put together a few scenarios.
For example, someone who starts saving £800 a year at the age of 20 will have a pot worth more than £46,000 more at retirement than someone who saves £600 instead.
|Age||Salary||Contributions 3% of salary per annum until retirement||Estimated pension pot at age 67||Contributions 4% of salary per annum until retirement||Estimated pension pot at age 67|
|Source: Better Retirement. |
Assumptions: Salary increases by 2.5 per cent per annum, contributions after tax relief, fund growth 5 per cent less 0.75 per cent charges.
The reason why a relatively small increase in pension contributions can result in such a large increase in the value of your pension pot is because of the power of compounding.
When you invest money in a pension fund you normally benefit from growth on your money. The next year you may get on both your original contribution and the growth in year one.
In the third year you may get growth on top of the gains made in the first two years and so on. Albert Einstein once called compound interest ‘the greatest mathematical discovery of all time’.
In simple terms, the earlier you invest your money the more benefit from you will get from the compounding effect and adding more money to your pension pot by increasing your contributions just makes the compounding effect better.
But the stock market doesn’t always go up and the reverse can happen. For example, you lose out from a downward spiral if the market falls for a continuous period.
Don’t forget you can grow your pension faster without paying more money into your pension pot by making sure you are not paying too much in charges and you are in the most appropriate investments.
You should review your pensions regularly to make sure they are in good shape and a good financial adviser will give you a ‘pension MOT’ for a modest fee.
You can also grow your pension faster by making sure you are getting all the tax relief you are entitled to. Many people find tax relief difficult but think of it as being like a government bonus. For £80 you invest in a pension the government will add a bonus of £20.
The more you contribute the bigger the bonus. If you pay higher rate tax the bonus increases from 20 per cent to 40 per cent of your contributions.
In answer to the second part of the question ‘…or should I just enjoy it now’, it is worth going back to basics and reminding ourselves what a pension is for in the first place.
A pension is designed to pay you an income when you retire. However, with the new pension freedoms you have the choice of taking your pension pot as a cash sum, purchasing an annuity which pays a guaranteed income for life or investing in pension drawdown.
This means that you have the choice of spending the money earmarked for your pension contributions on something today which may be enjoyable but not necessarily important or putting this money into your pension which is very important but will not give you enjoyment until you retire.
I think, and I would say this wouldn’t I, that it is better to put the money into your pension pot, especially as you will have the freedom to spend your pension pot as you wish anytime after age 55.
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