Pension Academy video series

Episode 4: How much do you need to pay into a pension?

Key takeaways

Setting a retirement income goal will help you figure out how much you need to contribute each month to meet it.

The earlier you start paying into a pension the better. And that's because of something called compounding returns or compound interest.

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Alright, now we’re getting to the juicy stuff! Let’s find out what you actually need to pay into your pension to retire comfortably. And if you stick around, we’ll even find out how you could retire with a £1 million pension. First, let’s start with a couple of basic concepts...

The earlier you start paying into a pension the better. There’s no doubt about it. And that’s because of something called compounding returns. Now don’t be put off by the financial lingo. Compounding returns is your friend! Let’s look at an example.

Say you put £100 into your pension, and that grows by 5% in a year. Now your £100 is worth £105. Now imagine that grows by 5% a year, again. Now it’s worth £110.25. Notice how it grew by £5 in the first year and £5.25 in the second? Every year, assuming it grows at the same rate, it will actually grow an increasing amount in real money terms. So after 15 years it would grow by £10 a year, and after 30 years it would grow by £20 a year. If you simply paid in £100 when you were 20, and it grew 5% a year, it could be worth around £900 by the time you’re 65 - at least, before fees are taken into account. But either way, compounding returns can help grow your pension more and more over time. So the earlier you start, the longer it has to work its magic.

Of course, pensions aren’t guaranteed to grow by 5% each year - or even at all. So you want to keep paying into your pension throughout your working life to make sure it’s topped up as much as possible. And this brings us to our second concept...

The more money you pay into your pension, the more it could be worth when you retire. Now that probably sounds like ‘Money 101’ and I guess it kind of is! But did you know that, if you start early enough, paying just an extra £10 a month into your pension could increase its value by £10,000 by the time you retire? And paying in an extra £50 could increase its value by £50,000.* So if you get a pay rise or come into a bit of money, consider increasing your pension contributions. Because even small increases could pay off in a big way when you really need it in later life.

So, start your pension early and contribute as much as you can comfortably afford. Those are the basic principles of saving for a happy retirement. Now let’s get to the numbers.

If you’re like me, you might be imagining retirement as a time to kick back with your friends, travel a bit, and spend more time with your family. But what does that kind of lifestyle cost? Well, according to research carried out by Which?, it costs the average retired couple about £26,000 a year. And for single people, it’s about £19,000 a year. Now, if you have a play with PensionBee’s pension calculator, like I have, you’ll see that if you and your employer contributed £150 a month from the age of 20, your pension could help you retire at 67 and afford a comfortable lifestyle until you’re 82. And if we add the income from your State Pension, which we’ll cover in more detail later, it would last beyond your 100th birthday.

But this is where it pays to start your pension early. Because if you wait until you’re 30, for example, you and your employer would have to contribute up to £200 a month for you to afford the same lifestyle. Obviously, if you’re self-employed or not working you’ll need to increase your contributions to make up for the lack of workplace contribution.

Now let’s talk about goals! Setting a retirement income goal will help you figure out how much you need to contribute each month to meet it. The pension calculator on PensionBee’s website can help you do this really easily. You just set your goal, put in the current value of your pension and what you’re currently contributing. You’ll know instantly whether you’re on track or not, and you can adjust the contribution sliders to see the impact of raising or lowering your contributions. It’s a great way to manage your money and your expectations!

Lastly, I did say we’d talk about that £1 million pension. So let’s see what it takes...

First of all, a £1 million pension gives you a lot of money to play with in retirement. So much, in fact, that you could take out £70,000 per year for 20 years. That’s a pretty decent retirement! But is it really doable for us regular people? Well, it’s not easy. But using everything we’ve learnt in this video, it is possible!

Firstly, you need to start young. And secondly, you need to contribute as much as you can afford. In this case, we’re talking about personal contributions of £400 a month from the age of 20. Now that sounds like a lot. But it works out at about a quarter of the average salary for someone that age, and it leaves about £1,200 to live off each month. If you live rent-free with your parents or guardian, that might be doable. And even if you don’t, it might not be too hard, depending on the cost of rent where you live. But one thing’s for sure... you’ll need to be really committed and careful with your money. And the good news is that if you start early, you won’t have to increase your contributions as you get older, meaning you’ll have more money left over each month as your salary increases. If you do start later - say, when you’re 30 - you’ll need to put away around £700 a month. And it goes up quickly with age. Putting that much away each month is a big ask, so if you’re really set on becoming a pension millionaire, start early!

Now before we wrap up this video, we quickly need to talk about allowances and tax. Yeah, I know... everyone’s favourite topic! But stay with me.

So, each year you can receive up to £60,000 in pension contributions without being taxed. And the government will top up any contributions you make up to the equivalent of your annual earnings.

Okay, let’s recap:
  • The earlier you start paying into a pension the better, thanks to compounding returns.
  • The more money you pay into your pension the
  • better. Even if it’s just an extra £10 a month, it can make a big difference to your retirement income.
  • Set a retirement income goal and figure out what you need to save, using PensionBee’s pension calculator.
  • If you’re putting a lot of money into your pension, be weary of crossing the pension contribution limit which could affect your income tax.
*Assuming standardised assumptions in line with long-term pension returns. Past performance is not a guarantee of future returns.

This video was presented by Patricia Bright on behalf of PensionBee. Patricia Bright isn't a financial adviser and the views and opinions expressed in this informative video are those of Patricia alone and do not constitute financial advice.

The content of this video has been reviewed by the pension experts at PensionBee and was confirmed to be correct and in line with current HMRC guidelines and legislation based on their understanding of current tax legislation as of 4 August 2023.

Remember, as with all investments, your capital is at risk.

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