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Why start your pension early?

Updated 26 May 2022

2min read

Nick Green
Financial Journalist

If you've already read our guide on how to start a pension, the next question is: when should you start one? The answer is, as soon as you can. 

The very best time to start a pension is when you are young. Making early pension contributions let you make full use of compound interest. This means that even small savings early on can be more important than larger savings later. So it doesn’t matter if you can afford only small payments into it at this stage – you can increase your payments later as your income rises.

Here you can find out:

  • What is compound interest, and how does it work?
  • What is tax relief, and how does it boost my pension savings?
  • How can a lower-paid person save a bigger pension than a higher paid person?
  • How starting a pension earlier can help you retire early.

The effect of compound interest on your pension pot

Consider two pension savers, Eloise and Harry. Eloise starts her pension at the age of 20, investing just £50 a month. Harry waits until he is 40, but invests £100 a month.

Supposing an average interest rate of 4%, when Harry is 60 he will have a pension pot of just over £36,500. Eloise, however, at the same age will have a pension pot of nearly £60,000. Notice that the two savers have invested exactly the same amount of money over time – but because of compound interest, Eloise has ended up with nearly twice as much.

However, both pots will actually be even bigger than that – thanks to tax relief.

The pension boost from tax relief

Compound growth isn’t even the best thing about a pension. What makes them unique is the tax relief they bring. When you make a payment into a pension, the government repays you tax at the highest rate you normally pay – which effectively means you are ‘given’ extra money.

This means that, in the example above, each time Eloise pays £50 into her pension, what actually gets paid in is £62.50. This is because Eloise (a basic rate taxpayer) normally pays tax at 20 per cent, and £62.50 taxed at 20 per cent would be £50. The money arrives in the pension as if it had never been taxed.

When you take tax relief into account, Eloise's final fund will actually be over £72,800.

As for Harry, let’s suppose he is a higher rate taxpayer. He pays tax at 40 per cent, so each of his £100 payments becomes around £166. However, even with this huge advantage, he won’t quite match Eloise, as he will finish with around £60,600.

From this example, you can see that a modest earner, receiving half as much tax relief, can still end up with a bigger pension pot than a higher earner – just by starting their pension much sooner. So remember, when it comes to saving your pension, time really is money.

How much should I be saving into my pension?

You will need to saving enough into your pension to provide you with a comfortable income in retirement. There are several ways you can work out how big a pension pot you will need, and how much you need to contribute per month. To work out your own pension contributions, use our quick guide to saving enough pension.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.