When you’re younger, retirement can seem a long way off. Especially when you’re on a lower salary, there’s always more pressing costs to spend your money on and your pension tends to take a back seat. If you’re in your twenties now you may not want to be locking your hard-earned cash away for the next 40 years, but it really pays off if you do!
They key to this is the bit of magic that is compound interest. Pension funds are built on this, and although good returns on investments aren’t guaranteed, compound interest is. If you’ve got a couple of decades to play with, then anything you can to a pension fund now will grow massively over the years. Even if retirement is only ten years away, there’s still time to build that nest egg!
- Save Small and Often
- Save With a LISA for a Cash Bonus
- £25 a Month Can Make a Big Difference
- How to Find the Extra £25
- More Useful Reading
If you can’t afford to lump large sums of cash into a pension fund, it doesn’t mean your dreams of retirement are lost! Even if you can’t afford much, contributing whatever you can, no matter how small, adds up over time thanks to compound interest and long-term investment returns.
If you struggle to stay on top of your finances spend some time creating a budget, working out where your money goes and whether you can cut back. Although retirement may feel ages away, saving whatever you can now will help.
Don’t opt out
If you’re eligible for a workplace pension scheme (and most PAYE employees are), your employer has to pay into your pension. That’s free money! You could opt out, which gives you a little more in your pocket each month – but unless you’re really strapped, staying in the scheme is best. That’s because opting out loses you a considerable amount of cash.
You could have £100 extra now… or, that £100 goes into your pension. On top of that, the Government tops it up with tax relief (so 20%, 40%, or 45% depending on which rate you pay). Plus, your employer MUST put in at least 3% of your salary too – so, assuming your £100 is the minimum 5% employee contribution, that means your employer tops up with a further £60. Assuming you pay 20% income tax, that means for the £100 you COULD have in your pocket right NOW, your pension gets a total of £180. That, plus compound interest over time, is a way to build your pension.
Lifetime ISAs offer cash bonuses to people saving either for retirement or to buy their first home. You can deposit up to £4,000 a year into a LISA, on which the Government gives you a 25% bonus. Say in one year you deposit your full allowance of £4,000, you’d receive an additional £1,000 bonus on top!
Anyone aged between 18 and 39 can open a LISA. If your 40th birthday is drawing near open an account quick to benefit! You can continue to deposit into a LISA until you reach 50, at which point you’ll only receive interest and potential returns on investments. Despite this, your fund still has another 10 years of growth before you can access the money when you reach 60.
Any bonuses earned are paid in monthly. As soon as the bonus reaches your account it will start earning you interest, or contribute towards your investments. Plus, it’s still an ISA, so on top of this you’re also benefiting from tax-free interest.
The one catch is that money put into a LISA has to be left alone until you reach 60, or used for a first-time buyer’s house deposit. Accessing the money for other reasons will mean you’ll face charges and losing your bonuses altogether. Having funds in a LISA could also affect your eligibility for means-tested benefits, as it counts as capital.
People on a low income can still save a small amount each month to build up a retirement nest egg.
Help to Save Accounts
Available to people on lower incomes, or receiving Universal or Working Tax Credit. Help to Save accounts give a bonus of 50p for every £1 saved over a 4-year period. You can save anywhere between £1 and £50 a month. You don’t have to save every month if you can’t afford to do so, but you can’t roll a previous month’s allowance to the next. So, if you don’t pay in the full £50 in one month, you still can’t pay in more than £50 the next.
You’ll receive the bonuses at the end of the second and fourth years, based on how much you’ve saved over that time. If you manage to save the maximum of of £50 a month, every month for 4 years, then not only will you have saved £2,400 yourself, but you’ll receive a bonus of £1,200, too!
But even if you can’t afford £50 a month, £25 can still make a difference. In this case, at the end of 4 years, you’ll have saved £1,200 with an additional £600 bonus from the government. Why not use this bonus to boost your pension fund but investing it straight away and get even more free money in the form of tax relief. If you’re a basic rate taxpayer, putting £1,200 into your pension pot nets you an extra £240 on top of that in the form of tax relief.
The Magic of Compound Interest
Time is the important player behind compound interest – the earlier you start the better the results will be.
Here’s an example. Mr. X has just turned 30, with no money in a pension fund. He decides to put in £25 a month, every month, until he reaches the new private pension age of 57. There’s an assumed average compound interest rate of 5%, which is common over such a period of time. Over that 27 year period, the total amount Mr. X invested was only £8,100 but the final size of his pension pot is £17,150! Meaning he earned a massive total of over £9,000 in interest alone.
But say Mr. X actually managed to put by £100 a month for his pension pot. In that case his final pension fund would be over £68,000, boasting a massive £36,203 in interest.
So it’s easy to see how quickly compound interest can add up, and how worthwhile it is to start as early as you can. Check out The Calculator Site’s Compound Interest Calculator to see for yourself how much your fund could grow.
Cut back in any ways you can – are you spending on anything unnecessarily? Maybe give up one takeaway or meal out a month, have one pint less a week down the pub, cut out your coffee on the way to work. Often we don’t think about purchases if they’re only costing us a couple of pounds, but it all quickly adds up.
Go through your direct debits and subscriptions and check whether there are any services you don’t need, or aren’t using any more and cancel them. According to Natwest, the average Briton spends £39 a month on unused subscriptions, standing orders, and direct debits!
If you can, think about minimising how much you use public transport. Not only will you get more exercise by walking or cycling instead (and be able to think about cancelling that gym membership, too!) but it will help you save the pennies. Research from Statista estimates that most of us spend close to £30 a week just on getting around.
As well as cutting back, look at ways to make money too. Not only is the MoneyMagpie Make Money section full of ideas but the new Marketplace has just been launched! You can sell your services, including things like dog walking and babysitting, to selling your homemade wares or secondhand items you don’t want.
You can check out our article on how to get started here.
Looking for more reading on pensions and how to prepare for retirement? Check out some more of the articles below.