Young people who delay pension saving until middle age could lose more than half a million pounds

Published by Malcolm McLean on

Young people who put off saving for a pension until they reach middle age could lose up to £100,000 in employer pension contributions and tax relief, a delay that could cost them as much as £665,000 by the time they retire.
Our research reveals the true cost of neglecting your pension:
  • workers who don’t save into a pension scheme until they are 40 could turn down nearly £100,000 in ‘free money’
  • turning down these contributions could halve pension income at age 70
  • pension fund value could be more than £665,000 lower at age 70

The research, which explores the financial implications for young people who do not enrol into a pension scheme until the age of 40, compared with workers who started saving at 25 years of age, across three defined contribution pension schemes with different levels of contribution, has been produced to highlight the importance of saving early.

According to the research a 25 year old, earning £25,000 pa, who delays joining a generous workplace pension scheme until they are 40 years old could miss out on £97,900 of employer contributions, tax relief and estimated investment returns in addition to their own contributions (see Case Study 3).  An employee who does not sign up to a mid-range scheme would lose at least £59,000 (Case Study 2).  Even a worker who did not join a scheme that offers the minimum contribution recommended by the government would miss out on £27,100 (Case Study 1).

Barnett Waddingham’s findings also show that a worker who had not saved into a pension scheme until 40 could halve the value of their potential pension fund and subsequent income on retirement.  While those saving from 25 years of age into a generous scheme could amass a pension fund of £1,275,400 at age 70, those saving at 40 would, in the same scenario, have a pension pot of £608,200 – more than 50% lower, with a £667,200 loss in savings.  Someone saving into a mid-range scheme would lose £444,800 in savings, while someone on a minimum contribution scheme would lose £221,500.

At current annuity rates this fifteen year delay, for someone who had access to a generous scheme, would dramatically slash annual pension income, from a potential £86,000 to £41,000.  For workers with lower contributions and investment returns, annual income could fall from £28,500 to £13,600, and from £57,300 to £27,300 for a mid-range scheme.

There is an understandable tendency for many young people, especially in these challenging economic times, to want to concentrate on their more immediate financial needs and not commit themselves to investing their hard earned money into any sort of long-term pension plan, the benefits of which they are unlikely to see for perhaps 40 years or more.

Nevertheless it is important that they have an eye on the long-term and don’t look a gift horse in the mouth. A workplace pension scheme is effectively that - an opportunity to receive 'free money' in return for a personal contribution of a, sometimes relatively small, designated amount.  Not to join such a scheme where available is tantamount to turning away wages.

This research shows just how much a young person could lose by delaying the start of their pension plan by fifteen years.  The message that many young people should take on board as the Government’s programme of auto-enrolment continues is that this is an opportunity to receive some tangible help in planning a better future for themselves.

Starting early is the key.  The state pension on its own is unlikely to sustain future generations beyond a bare minimum and building up a sizable private pension pot takes many years.  Young people today can expect much longer in retirement than their forefathers, but with better health prospects and a decent standard of living those could be good years.  The sooner they start planning and preparing for that important stage of their lives the better.

Starting to save from age 40

Case Study

Employee Contribution rate

Employer Contribution rate

Fund value at age 40

Fund value at age 70
(7.0% pa investment return to 60 then 4.0% pa to 70)

Annual annuity at age 70
 

 

 

 

 

 

 

1

5%

3%

£0

£201,900

£13,600

2

5%

5%

£0

£405,500

£27,300

3

5%

10%

£0

£608,200

£41,000



Starting to save from age 25

Case Study

Employee Contribution rate

Employer Contribution rate

Fund value at age 40
(7.0% pa investment return)

Fund value at age 40 minus employee contributions

Fund value at age 70
(7.0% pa investment return to 60 then 4.0% pa to 70)

Annual annuity at age 70
 

 

 

 

 

 

 

 

1

5%

3%

£38,700

£27,100

£423,400

£28,500

2

5%

5%

£77,600

£59,000

£850,300

£57,300

3

5%

10%

£116,500

£97,900

£1,275,400

£86,000

In all cases the figures assume annual wage inflation of 3%.  Figures have been rounded to the nearest £100. Case Study 1 relates to minimum contributions of qualifying earnings under auto-enrolment.

Additional figures available on request.

NOTES

Case 1

Young person aged 25 earning £25,000pa with access to a workplace pension scheme on a minimum contribution basis (3% employer, 4% employee, 1% tax relief of the qualifying band of earnings).  The employee  saves  £11,600 by not paying the required contributions over the  15 year period but misses out on employer contributions of £8,700 and government tax relief of £2,900 which in total with investment returns might have given him/her a pension pot at age 40 after charges of as much as £38,700.  The loss to the employee is therefore £27,100 (£38,700 - £11,600).

If the person continues contributing to the pension scheme until age 70, at 7% investment return per year until age 60, and 4% investment return until 70, the pension fund’s value would reach £423,400.  If the employee started saving at 40 years of age, on a minimum contribution basis, the fund would reach £201,900, and the loss of fund value to the employee would be £221,500 (£423,400 - £201,900).

With an annuity at the best rate (taken from the FSA Money Advice Comparative Tables) the pension fund for the employee saving at 25 would provide £28,500 pa (no spouse pension), compared with £13,600 pa (no spouse pension) for the worker that had begun saving at 40.  This represents a 48% loss in income per year (100/£28,500 x £13,600, rounded to the nearest per cent) of £14,900 (£28,500 - £13,600).

Case 2

Young person aged 25 earning £25,000pa with access to a scheme where he/she contributes 5% of salary and receives a matching employer contribution.  The employee saves £18,600 by not paying the required contributions over the 15 year period but misses out on employer contributions of £23,200 and government tax relief of £4,700 which in total might have given him/her after charges a pension pot at age 40 of as much as £77,600.  The loss to the employee is therefore £59,000 (£77,600 – £18,600).

If the person continues contributing to the pension scheme until age 70, at 7% investment return per year until age 60, and 4% investment return until 70, the pension fund’s value would reach £850,300.  If the employee started saving at 40 years of age, on mid range contributions, the fund would reach £405,500 and the loss of fund value to the employee would be £444,800 (£850,300 - £405,500).

With an annuity at the best rate (taken from the FSA Money Advice Comparative Tables) the pension fund for the employee saving at 25 would provide £57,300 pa (no spouse pension), compared with £27,300 pa (no spouse pension) for the worker that had begun saving at 40.  This represents a £30,000 loss in income per year (£57,300 - £27,300).

Case 3

Young person aged 25 earning £25,000pa with access to a scheme where if he/she contributes 5% of salary the employer will contribute double (10%).  The employee saves £18,600 by not paying the required contributions over the 15 year period but misses out on employer contributions of £46,500 and government tax relief of £4,700 which in total might have given him/her after charges a pension pot at age 40 of as much as £116,500.  The loss to the employee is therefore £97,900 (£116,500 - £18,600).

If the person continues contributing to the pension scheme until age 70, at 7% investment return per year until age 60, and 4% investment return until 70, the pension fund’s value would reach £1,275,400.  If the employee started saving at 40 years of age, into a generous scheme, the fund would reach £608,200 and the loss of fund value to the employee would be £667,200 (£1,275,400 - £608,200).

With an annuity at the best rate (taken from the FSA Money Advice Comparative Tables) the pension fund for the employee saving at 25 would provide £86,000 pa (no spouse pension), compared with £41,000 pa (no spouse pension) for the worker that had begun saving at 40.  This represents a £45,000 loss in income per year (£86,000 – 41,000).

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