Will it really improve my retirement if I increase my pension contributions by 1% – or should I just enjoy the money now?
When retirement is decades away, it’s understandable that many people near the start of their working lives don’t give a lot of thought to exactly how much of a difference the amount they pay into their pension will make when they finally come round to needing it. Increasing your pension contribution by 1% might sound so small as to be insignificant, making it tempting to choose to enjoy more of your hard-earned money today rather than putting a little more of it away for years to come. But is that really the case? What difference would putting an extra 1% into your pension actually make?
The simple answer is ‘quite a lot’. Let’s assume that you currently contribute 3% of your salary every year to your pension until you retire, and you increase that to 4%. Someone at the start of their career aged 20 and earning £20,000 contributing 3% would be paying in £600 annually, giving them an estimated pension pot of £139,051 if they retired at 67. If they upped their contribution to 4% that would mean paying in £800 per year and an estimated pension pot at 67 of £185,401, giving them an extra £46,000 to enjoy in their retirement.
Even increasing your payments later in life can have a significant impact. Someone aged 50 and earning £35,000 would pay £1,050 to their pension every year making a 3% contribution, or £1,400 if they made a 4% contribution. As a result, their pension pot would be over £10,000 bigger at age 67: £31,367 compared to £41,823.
The reason for the significant growth in savings with just a relatively small increase in contribution is thanks to compound interest. So after your first year of contributions, you’ll earn interest on everything you’ve saved but in your second year, you’ll earn interest on both your total contributions and the interest earned from the first year. This continues throughout your working life, meaning that the more money you save as early as possible, the more you’ll have to enjoy when you need it after you finish working.
As for ‘enjoying the money now’ instead of saving it for the future, it’s important to remember that the introduction of pension freedoms means that anyone aged over 55 can choose to access their pension and take a lump sum to ‘enjoy’ however they wish. Whilst you should ensure you’re not preventing yourself from treating yourself within reason, having a little less money available to spend whilst you’re young, in order to live comfortably and enjoy your retirement years to the full, is almost certainly the better financial choice when looking at the bigger picture.