By Rachel Wait
Unless retirement happens to only be a few years down the
track, giving up work for good is probably only a distant dream. As a result,
putting money into a pension pot may not be at the top of your agenda.
However, neglecting your pension or delaying contributions
can be a big mistake and ultimately it will result in you being a lot worse off
when you do come to retire.
After all, if you were to only retire on the State Pension, you
would receive up to £102.15 a week (for the year 2011-12). The exact amount
depends on how many qualifying years of National Insurance you have, but it
really isn't much.
Although some people will also qualify for an additional
State Pension, if you want to live comfortably in retirement, relying on the
state isn't an option. So it's up to you to ensure you have saved up enough for
your later years.
Don't delay
To give you an idea of how much you could lose out on if you
delay starting a pension, let's look at some examples.
Imagine you start contributing to your pension pot at the
age of 25, with a monthly contribution of £150. If you retired at 65, according
to Hargreaves Lansdown, your projected pension fund would be £144,402*.
However, if you started contributing to your pension at the
age of 30, your pension pot size would only be £101,152 – so you would be losing
out on more than £43,000.
If you were to delay by a further five years and start
contributing at the age of 35, your pension pot would be £69,557 by the time
you reached retirement. As a result, you would lose out on more than £74,000.
Worst of all, if you were to only start contributing to your
pension at the age of 40, your pension fund would come to just £46,603. That's
£97,799 less than if you started your pension when you were 25.
Compound interest
Starting a pension early means you will receive the full
benefits of compound interest. This is where you earn interest on your
interest.
For example, when you start contributing to your pension,
you will earn interest on that money. The following year you will earn interest
on both the amount initially invested as well as the interest from the previous
year. In the third year, you'll earn
interest on the amount invested as well as interest from the previous two years
– and so it goes on.
So the longer the money is invested, the more you will have
to live off in retirement.
Increase your
contributions
Of course, if you can increase the size of your pension
contributions, you'll also enjoy a larger pension pot by the time you reach
retirement.
For example, if you start contributing to your pension at
the age of 25 at £150 a month, we've already established that your pension pot
would be £144,401.
However, if you increase that contribution to £200 a month,
your pension pot would be £192,535. And if you increased your payments by
another £50 to £250 a month, you would have a pension pot of £240,669.
Of course, not everyone can afford to do this – particularly
in the current climate. But even if you can only afford to increase your
contributions by a small amount, this could still make a big difference to your
retirement.
Tax relief
Don't forget that when you contribute to a pension you will
also benefit from tax relief. If you are a non-taxpayer or basic rate taxpayer
you'll receive 20% tax relief – so for every £80 you pay into your pension, HM
Revenue and Customs (HMRC) will top it up by £20 – taking the total to £100.
If you're a higher rate taxpayer (40%) you may be able to
claim additional tax relief. Depending on how much you earn over the higher
rate tax band, this additional tax relief would range between a further 1% up
to a maximum of 20%.
And if you're an additional-rate tax payer (50%), you may be
able to claim additional tax relief at your highest rate. Depending on how much
you earn over the higher rate tax band and your level of contribution, any
additional tax relief would range between a further 1% up to a maximum of 30%.
*Projections from
Hargreaves Lansdown are based on 7% compound annual growth rate, with contributions
increasing by 2.5% a year. An annual management fee of 1% has been deducted
from the growth rate. Projected values are in real terms – so they have been
discounted to reflect the impact of inflation at 2.5%. Result figures have been
rounded up.
