This edition of the Mortgages Money and More podcast looks at when is the right time to start investing in your pension, with Craig, Jamie and Jason.
A few weeks ago we did some myth busting and this was an important area – can it be too late to start investing in your pension, or even too early? So, we’re following up with a more specific podcast around timing.
Can it ever be too early to invest in your pension?
The big question is why is it too early? How long do you need to pay into a pension? Well, it depends what your aspirations are for retirement. If you want to work until you’re 90 years of age, then yes it’s okay to start paying into a pension when you’re 40. But the reality is that nobody wants to work that long. Most people aspire to retire early, in which case, why do they think it’s too soon to start a pension?
People just don’t like the thought of having to physically start paying several hundred pounds a month into something when they’re at an age where they want to enjoy that money and have a good lifestyle. That’s the main obstacle.
When you’re saving for a deposit for a house, you’re putting savings away every month. Next you’ve got a mortgage – a big debt. People say to us all the time: “Well, I just need to get my mortgage sorted out now. I can’t afford to do that and put money into a pension.” But when you’re looking at starting a pension, compound interest plays a massive role. It’s an investment in your future.
Changing the mindset of younger people
Many people at a young age aren’t really sure what a pension does or how it works. Plus, auto-enrollment doesn’t happen until you’re over the age of 22. At that age we struggle to think about what life is going to be like in another 50 years’ time.
But we need to get young people thinking that if they can afford to put this money to one side, it’s not going anywhere. It’s their money at the end of the day.
Everywhere you look now there are multi-millionaires doing very little in life. And sadly, people think, well, it’ll come to me, I won’t need a pension. I’ll end up with millions of pounds one day so it’s not really important. But our job is about being educational, trying to give people the facts and the figures and the information to make up their own minds.
Auto enrollment is brilliant, because it forces people to join a pension. But then it also gives them the option to back out if they wish. People have a temptation to cash in – if they’ve been paying for less than a couple of years, they can actually get the contributions back out again. Some people just see it as a short term savings scheme and cash out the pension very early, and it’s really sad to see that.
Be entrepreneurial about the future
There are so many people being entrepreneurial, starting a business at a young age. They’re coming out of education and don’t want to work in a corporate world. And that’s brilliant. But they should also be investing into a pension very quickly. Yes, you’re getting your business off the ground, but a pension offsets against your tax. It’s a great reason to start putting money away.
When you’re setting up a business yourself, you turn to so many people for help and advice. Everybody should be employing a financial adviser as part of that, to take care of your pension and planning for the short, medium and long term.
Don’t just stick with minimum contributions
It’s very rare that you see anybody piling into that pension until later in life, when they start to understand the effect of it. You see amounts of £50, £60, £70 a month going into a pension. People have the mindset of “well, I’ve got a pension, I’m okay”. But we all know that £70 a month isn’t going to amount to much or give you a comfortable retirement.
People live by their means. They’ll just get used to a payment going out and factor that into their everyday living. But then they are saving for the future. It’s just that mindset, really, to put something away each month and forget about it.
It’s like mortgage interest rates coming down. People might start on the property ladder with a 95% loan to value mortgage, paying £500 a month, and then two years later the rates have gone down and they’re paying £450 a month. What do you do with that £50? You’ll just spend it. Nobody ends the month with £50 more – it just goes, you just spend it on everyday life. But you could put that £50 into your pension pot for the future.
The power of compound interest
The time that you spend investing your money is really important. With pensions or just general savings, you’re investing for the long term. Remember that your initial investments are going to be there for potentially 30 or 40 years. The way that interest and returns work is that you get growth on those first initial investments.
It’s like a snowball. Year after year, you’ll see that interest being added. In the years there’s growth upon growth upon growth.
One example really brought it home to me. It was something like: if you invested £10,000 at 5% interest, in 30 years’ time it would be worth £40,000. That’s £30,000 from £10,000 – we’ve made three times the original figure just in interest. I struggle to think of anything other than property that’s going to rise like that. It just makes such a difference to give that time to your investment.
Compound interest generally is something that you would relate to a bank account or savings account. It’s quite easy to track how that investment has grown over the years. But when you look at investments that are linked to the stock market it’s not really compound interest, it’s compound growth. You’re buying units in an investment and over time the value of those units increases. But what you’re doing underneath is you’re using the growth to accumulate more and more of those units that – hopefully – will increase in value over the years. There’s going to be times when they go down as well as up, but that’s the nature of the beast.
Don’t bury your head in the sand
A lot of people don’t even want to start understanding pensions. They leave it as a problem on the back burner, hoping someone will come along and sort everything out for them.
We see a lot of people later on in life, and everything comes down to the sum of money that they can put aside each month and what they will have to sacrifice. If we’ve only got £100 spare in their monthly budget, and they’ve reached age 50 and they want to retire in five years, it’s going to be impossible to get them the amount of money they would want to retire on.
It’s about trying to balance their expectations. We’ll show them what will happen if we put extra money in. It might be a large contribution from your monthly income, but in ten years time, we’ve got a really good chance of getting you the amount that you want to retire on.
Or it could be going for a shorter term to retire on time but at a lower income level. Just understanding that position gives all that power back to you to make an informed decision.
Avoid the danger zone
We have to be enthusiastic and encourage clients to pay into a pension because something’s better than nothing. There are certain danger zones. If somebody’s never had a pension before and are thinking of putting £50 a month away, I will need to manage their expectations. £50 a month for the next ten years isn’t going to give you much back in terms of pension income.
At state retirement age, someone who’s never had a pension in their whole life might get the state pension and find that they can’t manage to live, but they might qualify for certain state benefits. On the other hand, someone who’s maybe paid £50 a month into a pension might also struggle to manage the cost of living. But because they have a small pension pot, they may not be eligible for benefits. So having a pension and having a good pension are two different things.
So while something’s better than nothing, you do need to sit down and take this really seriously. It might be that the sort of premiums that you need to pay to get a good pension are unaffordable for a lot of people.
So when is the right time to start a pension?
My answer would be today. Today is the day to take action and take control. Get advice so that you understand where you’re at and what it will take to have a comfortable retirement.
With today’s online access to pensions, you can track it and see it grow. Sometimes the growth will slow, or even reverse, but you can see a growth over time. It means you can stop and think, am I on track? That’s why we sit down with our clients for annual reviews. If your £130 a month needs to be £150 – you’re doing something about it today, which will have a massive effect. As Jamie said £10,000 becomes £40,000 over the years if you do something about it now.
And the biggest selling point for pensions is tax relief. If you’re getting tax relief on your pension, you can view that as growth on your money overnight. I’ll challenge anybody to go out there and find a savings account that’s going to pay them 20% – your income tax rate. There are additional tax breaks when you come to draw your pensions. So with tax free cash it’s money for nothing.