There is a childishly simple way to double your money with retirement savings. But it requires a real effort to change your priorities.
It all comes down to compound interest. The longer your money is invested for, the faster it grows. What that means is that every £1 you save towards retirement today is worth two or three times the £1 you save 5 or 10 years later.
Legal & General shows that for a 25-year old aiming to retire at 60, the amount you need to save to generate a £20,000 a year pension income is £205 per month if you start now but £423 per month if you don’t start saving till you’re 35.
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Waiting for a double
My way of looking at it is to ask how long it will take before the sum in your savings account is worth double what you have paid in. Obviously that depends on the rate you earn on your contributions, and I will assume 4.5%, in order to allow for inflation (at an average of 2% a year) and charges (0.5% a year). That means the comparisons are like-for-like, the final amount being in terms of today’s money in spending power. This 4.5% rate may sound low, but remember it is ‘real money’, and it is in line with the average long-term returns from investing in shares.
So let’s say you have 20 years to retirement. You sign up to a pension plan and pay in £80 per month. Tax relief is collected in the plan, so £100 per month is invested on your behalf. At the end of 20 years, there is £38,800 in the plan and you have paid in £19,200. You have doubled your money.
Over 15 years, your contributions would be £14,400 and the plan value £25,600, overall a 77% uplift over your net contributions. Over ten years the plan value would be £15,100 for an uplift of 57%. The shorter the term, the lower the uplift.
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You can't afford not to save
Of course it is true that most of us can’t afford to save as much as we need for retirement. But the truth is that once you’re past the age of 25, you can’t afford NOT to save for retirement. The important thing is to make some contributions, however low, into a retirement plan.
If your employer doesn’t offer an occupational pension scheme, they will have a ‘stakeholder pension’ scheme open to employees, though the employer doesn’t have to contribute anything. But the charges are 1.5% a year, which is far above the proposed charge of 0.3% a year for the Personal Accounts the government aims to introduce in 2012.
So ignore stakeholder plans and instead go for a low-cost personal pension plan. Fidelity’s is fine if you save over £300 per month - there is no set-up charge and no annual charge. All you pay is the annual charge of the funds you invest in, and here you can use Fidelity Moneybuilder UK Index, a UK index tracker fund, and pay just 0.3% a year.
For smaller contributions, Hargreaves Lansdown’s Vantage SIPP also levies no annual or initial charges for fund investors and has a lower monthly minimum of just £50.
Putting off starting a retirement savings plan is easy. But don’t kid yourself. It will never be easy to start saving and the longer you leave it, the more you’ll need to save to get the same retirement income. So start young, even with low contributions, and get into the habit of topping them up at regular intervals.
Retirement savings: find out more
