It can be hard to get energised about retirement saving, particularly when you’re young and retirement feels so far away.
I was recently told of an acquaintance who has been wrestling with this familiar problem. They are still only around 30-years-old and recently became self-employed, so have no employer who can helpfully nudge them into a pension and contribute on their behalf. After some thought, they have decided that they have greater priorities to concentrate on right now, with a business to make a success of and a first home to save for, so saving into a pension will have to wait.
That’s an understandable view to take, given their circumstances, but I can’t help but feel they will live to regret it. Very few people who have saved into a pension reach retirement and regret that decision. Most will have wished they saved earlier and saved harder.
Here’s four reasons why overcoming savings inertia is a good idea - and may not mean the sacrifice you think it does.
- There’s never a perfect time to start
It’s easy to think of reasons why you shouldn’t save. Young people face a difficult task to build the money they need for a first home and if they live in an area where rent is expensive, the need to buy and put your money towards repaying your own mortgage, rather than someone else’s, will feel even more acute.
But be aware that there will always be another priority demanding your time and money. If it isn’t a first home it could be children, or that second step on the property ladder. As hard as it might seem, building financial security means working on all these obstacles at the same time. You may not be able to put much aside for retirement at first, but saving is habit-forming and you can ratchet things up later - but that’s easier if you’ve already made a start.
- Time is on your side - if you act now
Perhaps the greatest weapon in building a healthy pension pot is completely free - time. Compounding means any return you make builds your capital and gives you an even bigger base to grow in the future. Over many decades, the effect on your overall pot can be dramatic, but if you delay your pension you’ll miss out on the potential benefits of compounding and have to make up ground later on.
To show the effects of delaying your saving, Fidelity conducted research to see how much of your income you would need to save at different ages in order to provide an income that would maintain your lifestyle in retirement. It showed savers should be putting away at least 13% of their pre-retirement annual income before tax, each year, from the age of 25. But this figure grows to 15% if saving is delayed until age 30, and to 18% if its delayed to age 35.1
- Tax relief makes it cheaper than you might think
Contributions into a pension benefit from tax relief, and this has the effect of making them less expensive than you might think.
For example, a £1 contribution today costs you 80p if you’re a basic-rate taxpayer, as little as 60p if you’re a higher-rate taxpayer and 55p if you pay additional-rate tax. Rates of tax relief for Scottish Residents may differ to the rest of the UK. The relief for higher rate and additional rate tax often has to be claimed for via a self-assessment tax return - in which case you would get the benefit through an adjusted tax bill the following year. The exception to this is some workplace schemes where the relief for higher and additional rate relief is automatic.
- Housing carries its own risks
If you are planning, like my acquaintance, to prioritise buying a home instead of saving for retirement be aware that translating that housing wealth into a retirement fund later on may be more difficult than you think. Often people will say that ‘my property is my pension’, without giving much thought to how they will make that happen.
Perhaps you think you will own multiple properties in the future, allowing you to collect rent on one or more of them. Perhaps you believe you can downsize or move to a cheaper part of the world to free up some cash held in your home.
But be aware that buying and selling houses is a costly process with expenses like stamp duty, legal fees and the cost of moving to pay for. If you are buying a second home you will have to pay even higher levels of stamp duty, while the tax on rents has been getting higher and more difficult to administer.
Saving into a pension on the other hand is tax efficient because, as well as the boost of tax relief, you will also be able to access 25% of your pot tax-free.
That means it can be much simpler in the long run to keep your home for living in, and fund your retirement income via a pension, which is designed for the job.
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saving for retirement in your 20s and 30s
1 Fidelity International, November 2020
Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. The minimum age you can normally access your pension savings is currently 55, and is due to rise to 57 on 6 April 2028, unless you have a lower protected pension age. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.