Are you aged 25 or under and clueless about saving for your future? Or a parent who wants to help their child realise the importance of investing for your retirement? Here’s everything young people need to know about pensions.
Many young people today aren’t really thinking about their pension, and often don’t realise the benefits of starting today rather than later. And that’s understandable. After all, if you are young, your retirement and therefore your pension is a long way away, and you have so much to think about and do before then.
But with a little knowledge you can use that time to your advantage, and give your savings longer to grow. In this article we will find out why it is so important to start your pension when you are young, and what you can do now.
How many young people have pensions?
So to start with, let’s find out just how many young people do have pensions. According to Legal and General, as of August 2024, 16 million people in the UK were paying into defined contribution pension schemes, many of which are workplace pensions.
But how many of these people are young? Research from Money & Pensions service reveals that one in three 18 to 25-year-olds who are currently working have never even contributed to a pension.
And research from People’s Pension discovered that approximately one in eight young adults (12%) – equivalent to around 2.2 million people – feel that engaging with their pension is useless because they will never be able to retire.
Why it’s important to start paying into your pension as young as possible
The truth is that if you DON’T engage with your pension you may never be able to retire. Or you could face financial hardship in your old age.
But if you do start paying into your pension when you are young, and you keep investing throughout your career, you could build a nice nest egg to fund the kind of retirement you want.
The key reason for this is something called compound interest or compound growth. Compound growth is the interest calculated on the principal (the amount you have invested) AND on the interest you have accumulated to date.
So, let’s say you invest £1,000 into your pension, and achieve growth of 5% a year. In year one, you earn £50 interest on that £1,000. But in year two, your growth comes from both the £1,000 AND the £50 you earned in year one, so you earn £102. Here’s what this looks like over time:
- In year 1 you earn £50 interest
- In year 2 you earn £102 interest
- In year 3 you earn £158 interest
- In year 4 you earn £215 interest
- In year 5 you earn £276 interest
That’s all on just £1,000 invested once. Now imagine what that could look like over time if you invested £1,000 or more every year.
In fact, if you invested just £1,000 a year (£83 a month), every year, with a 5% interest rate, after 40 years you could have £120,316 – £80,476 of which is compound growth.
And if you doubled that to £2,000 a year (£167 a month), in 40 years you could have £242,082, £161,922 of which is compound growth.
Of course you may not have £167 a month to invest in a pension now, but every penny you can put into a pension while you are young has the opportunity to benefit from compound growth. And as your career progresses over time, you can increase your contributions in line with salary rises.
The later you start paying into a pension, the less time you have to take advantage of compound growth, which is why it’s important to start one as soon as possible – even if you are only paying into a small amount to begin with.
How much do you need to pay into your pension?
To give you another idea of just how powerful compound growth can be, and why you have a golden opportunity to make the most of it, here is what you would need to pay into your pension if you wanted a retirement pot of £500,000 and your growth was 5%:
- Starting at age 20: £246.74 a month
- Starting at age 30: £440.11 a month
- Starting at age 40: £839.62 a month
- Starting at age 50: £1,870.63 a month
And if you wanted a pot of £200,000 here’s what you’d need to pay in:
- Starting at age 20: £98.70 a month
- Starting at age 30: £176.04 a month
- Starting at age 40: £335.85 a month
- Starting at age 50: £748.25 a month
As you can see, the sooner you start investing, the less you would need to pay in to achieve the retirement pot you wanted.
The tax benefits of contributing to a pension
There’s another good reason why it’s a good idea to start a pension when you are young, if you can afford to. And that is ‘free cash’ from the government. Or, in other words, tax benefits.
The government wants to incentivise people to save for their future, so it gives tax benefits to you when you do.
One thing you may have heard of is auto-enrolment. If you are over the age of 22 and earn over £10,000 a year, by law your employer must offer a workplace pension scheme and enrol you in it. Even if you don’t automatically qualify, you can ask your employer to add you.
The minimum contribution for auto-enrolment is a total of 8%. This is usually made up of 4% from your wages, 1% from the government in tax relief, and 3% on top from your employer.
If you wish, you can also pay in more. This is taken from your salary before tax (potentially reducing your tax bill) and some employers may match your contributions.
Even if you are not working, you can pay up to £2,880 into a pension every year and the government will add £720, meaning a total of £3,600 is contributed.
And remember compound growth? Even if you only paid £2,880 into your pension once (plus the government’s £720), in 40 years, with 5% interest, that could have grown to £25,343.
What about the State Pension?
Some people choose not to pay into a pension because they assume the State Pension will help them. But you can’t rely on the State Pension to pay you enough to live on, depending on your lifestyle.
The full State Pension today is £12,547.60 a year. However, according to Retirement Living Standards, we currently need £13,900 a year as a single person, and £22,500 a year as a couple for a minimum lifestyle, and £32,700 and £45,400 respectively for a moderate lifestyle.
This leaves a shortfall of £1,353 a year on a minimum lifestyle if you are single, and a gap of £19,906 for a couple if you wanted a moderate lifestyle.
And there’s no guarantee as to what the State Pension may look like when you get to retirement age. So it’s dangerous, in our opinion, to rely on it to fund your expenses when you retire.
Start saving into your pension today
According to research by Aviva, 49% of people in the UK over 50 regret not saving into their pension sooner, and 64% wish they had contributed more into their retirement savings at an earlier stage. And women are usually worse off than men.
If you are just starting out in your working life, you have a big head start on them. You now know the importance of investing in a pension when you are young, and have plenty of time to benefit from compound growth.
And yes, we get that there are lots of other things competing for your savings when you are young – a car, education, a holiday, a wedding, buying a property and life in general. And sometimes you can enjoy tax benefits on other forms of savings too, such as an ISA or LISA.
But it is important to also think about when you are older, and ensure you don’t miss out on the tax and compound growth benefits of starting to invest in a pension when you are young.
So make sure you stay opted in to any workplace pension you are offered, and increase your payments beyond the bare minimum as much as you can afford to. And if you’re not covered by auto-enrolment, you can find out how to start your own pension here.
You can find more advice on retirement planning in your 20s by PensionBee here.
