Is a pension worth investing in nowif you're going to be earning a lot more later?

ollieg90

Here's my situation.

I'm 22 and starting in a profession with good prospects. My firm has an up to 10% contributory salary sacrifice pension scheme available as part of my benefits package.

I've been told that the earlier you start a pension plan the better. However, while at the moment I'm a basic tax tax payer, after training and professional qualification in about 5 years time I'll be well over the higher rate tax amount. Given salary prospects in my industry it's likely that I'll be paying the additional tax by the time I'm 40.

Given that my pension contributions later could dwarf what I can contribute now, is there any point in me starting a fund now, or should I focus on other things like saving for a housing deposit, for example?

Cheers

BoGoF

How much is your employer contributing?

Alot_does_not_exist

In my opinion there's nothing like starting early with an amount you can find it comfortable to pay.

People who start late often find that they have left it so long (much to their considerable amazement - time has a habit of slipping by at an increasing and, worse, unnoticed rate!) that they are rushing to play catch up.

Yes, you may think you need to save for a m'gage deposit now... but later you may also have other, equally desirable/important financial objectives which at the moment would not be at all obvious.

You would then be trying to make large pension contributions within a budget which might make them unaffordable.

dunstonh

I've been told that the earlier you start a pension plan the better.

It is correct in that the longer the term you have, the less you need to pay in each month as you are spreading your cost of retirement over a longer period. i.e. if you assume that your retirement provision is going to cost you £750,000 in todays terms, then finding £750k over nearly 50 years is easier than finding it over 20 years.

So, whilst one argument could be that putting it off till later may get you greater tax relief, the other will be that you have to much more in each month to fund the need.

There are always excuses to put it off. First it will be funding the deposit. Then it will be funding the mortgage and funding the furniture and refurbishment. Then it will be marriage, then children and before you know it you are in your mid 40s with just under 30 years to find a million pounds (inflation will push the amount you need up)

If you get to 40 and have no provision, you would be looking at having to pay around 20-30% of your salary into your retirement provision. Finding that sort of money then on your lifestyle used to that amount of income will not be easy. It doesnt matter if you are earning over £150k like you think. You get used to an income level and you live to it. To suddenly have 30% of your money go will hit you. Whereas if you start earlier and pay less then you wont notice it as much. It will just be another bill like the gas or electric.

If employer pays anything then you take it as quick as you can. Nothing beats free money.

missile

Be careful, always check the small print. In my early career I worked for a well known and highly respected company who had a very generous pension scheme. Only after I left their employ did I find out those with short service (less than three years) were not entitled to any pension benefit.

atush

My firm has an up to 10% contributory salary sacrifice pension

If 10% is the max company contribution then you would be a fool not to take this 'free money'.

sandsy

Think of it this way: if you saved £200 a month for the next 10 years then added nothing to it, you would have more in your pot in 40 years time than if you started saving £200 a month in 10 years time and kept it up for 30 years. That's the power of compound interest.

OK, that's not exactly what you're thinking of doing as presumably, if you waited 5 years before you started, you'd anticipate paying in more than you would if you started now. But starting now gets you in the habit. Plus there's potentially free money from your employer - why would you want to turn that down? And free money from the government? OK, it may only be 20% at the moment but where else are you going to get an immediate uplift of 20% on your investment?

Basically, the sooner you start, the better!

ollieg90

Ok, thank you for that. I think a pretty clear consensus has formed around starting as early as possible, even if it is a smaller amount. I quite like the idea of it being just another bill, hadn't really thought of it that way.

Just to clear something up, my employers run a benefit credits system, so while I could have up to 10% contributions, that would be in return for sacrificing other benefits such as health insurance, commute subsidies etc. So it's not 'free' in that sense.

ermine

It depends what else you are trying to do. This paper from the pensions institute inidcates that a rational life-cycle investor into a DC pension scheme may prefer to start later, and your case fits one of their example premises (a rapidly increasing human capital).

What you buy when investing in a pension early is a certain degree of insurance against adverse financial circumstances later on. For instance, you profession with good prospects may suddenly become outsourceable to India. Radiologists thought they were immune from this but high speed data connections changed that. Paralegals also thought that but it turned out otherwise.

It is not true that early contributions always beat out later ones. They do if your disposable income remains constant. It doesn't, however, because you accumulate wealth over your lifetime. I am 50+ and have saved twice my gross salary into a pension and ISAs over the last three years, because I am pig-sick of the changes at work and want to retire early. Saving 70% of my income now is a much easier ask than saving even 5% would have been in my twenties. To a first approximation that Johnny-come-lately effort adds roughly the same amount to my pension savings as compound interest would have done had I been saving at 15% for the last 30 years (the total time I have been working). This is possible for me because I have paid down my mortgage and carry no debt at all. Since I have almost no housing costs I can easily live off less than the National Minimum wage and use salary sacrifice to stop the Government stealing 42% of my income.

You are taking risks, but this Moneyweek article makes the case for an alternative viewpoint to the start early, young man mantra. If you consider this way, you must take time out to understand why everybody else says start early, and model using Excel your likely career profile and savings rate. For a 40 year working life aiming at half salary you should assume a savings rate of about 16% and a investment return in real terms of about 5%. Use one row for each year and compute the saving and the effect of compound interest @ 5%.

You may also want to bear in mind that the stock market has taken a hammering in the last few years and the economy is on its knees. Paradoxically, that is a very good time to be saving into the stock market because valuations are cheaper. We will probably take even more of a hammering if/when the Euro finally explodes. That is the time to be saving, regularly, so there is something to be said for starting savings now, particularly with a 10% leg up from your company and a 12% NI leg up from salary sacrifice (asuming you are a 20% taxpayer now and will be a 20% taxpayer in retirement).

Derivative

"Rational" is the key word here.
I don't see how saving into a pension can beat saving for a house deposit.

Your fund would have to grow more than the difference in your rent and mortgage interest yearly for that to be a reasonable proposition.

As above, I think it's ridiculous to use these silly "put in £200pm for 40 years vs 35" comparisons, because that's not how it works. The earlier you buy a house, the quicker you can start to ramp up your pension contributions, and the less money you 'waste' renting.
If I were to own a house currently as opposed to renting, my 'disposable income' would more than double.

Comparing saving for a house deposit to 'saving' for a wedding or furniture is not sensible.
One of them is increasing your net worth long term, the other is decreasing it.

edit: Of course, this is on the assumption the house you're being (to an extent) rational in purchasing a house - i.e going for the cheapest place possible that you'd be happy to live in and is in the right location.

dunstonh

the pensions institute inidcates that a rational life-cycle investor into a DC pension scheme may prefer to start later,

However, most people are not rational and behavioural finance is the more common model. It is the single biggest area where cashflow modelling falls down. The rational argument does make some interesting points but people are not robots and life rarely goes as planned.

Never put off until tomorrow, what you can do today.

Ok, thank you for that. I think a pretty clear consensus has formed around starting as early as possible, even if it is a smaller amount. I quite like the idea of it being just another bill, hadn't really thought of it that way.

At your age, if you wanted £10k p.a. pension income at retirement in todays terms (i.e. todays spending power), then it would cost you around £135pm gross or £108pm net. Asking to do the same at age 42 would cost you £400pm.

If you have a lifestyle of an additional rate taxpayer then dropping down to £10k in retirement is not likely to appeal. How many multiples of £400pm are you going to want to be pay or even be able to pay into something that you have never paid into before. If you start with a smaller amount and increment it periodically, it is bite size chunks. As each payrise comes, you put some in the retirement planning and some in your pocket. You wont miss what you never had. However, once you have it, then going backwards is much harder.