While an important benefit of pensions is the tax relief they offer, another is the growth potential they can offer over the long-term. One reason for this is ‘compound growth’, which can help to boost the value of your retirement fund and turn your dream retirement into reality.
Read on to discover more about compound growth and why it’s usually at the heart of a pension scheme. Before you do though, we need to look at what happens to your money when it’s placed it into your pension scheme.
Typically, your pension contributions are placed into a variety of assets.
When your money reaches your pension provider, it normally places it into a range of assets in a bid to expose it to growth potential. These assets normally include:
- shares
- Government bonds
- cash
- commercial property.
Any growth these assets enjoy increases the value of your pension pot, which in turn, means you could draw more in income when you decide to retire or semi-retire. While this is simple enough, the growth your pension enjoys is likely to be boosted by ‘compounding’, which we will look at in more detail next.
Compounding is growth on the growth your pensions already made
While it’s said that Albert Einstein called compounding the ‘eighth wonder of the world’, the best description of it was probably made by Benjamin Franklin who said:
“[It’s when] money makes money. And the money that money makes, makes money”
When it comes to pensions, this means that any growth the investments that are held within it make, is then exposed to further growth potential in the future. To demonstrate this, you might want to consider the following example.
If you use a compound growth calculator, you will see that if you invested £100,000 and achieve an average growth of 3% every year, you could have around £103,000 at the end of the first year.
If you leave it invested, the 3% growth is based on £103,000, meaning your money could grow to £106,175 at the end of year two. This means that if you remain invested for 10 years, your initial investment could be worth £134,935 due to compound interest.
This compares to £130,000 if you received 3% simple interest, meaning your money grew by an additional £4,935 because of the growth it enjoyed on the growth it made.
The longer you invest for, the greater the potential for compound growth
While the above example makes for compelling reading, it only tells half the story. The other half is the effect time has on compound growth, as the longer you let it work its magic, the greater the potential benefits.
For example, if you invested the above amount over 20-years instead of 10, it could be worth £182,075 with compound growth. In other words, your money will have grown by an additional £22,000 when compared to simple interest.
If you remain invested for 30 years, which is perfectly possible with a pension scheme, compounding could boost your pension by an impressive £55,684. At the end of the three decades your £100,000 investment might be worth around £245,000
Please note that this is an illustration only to explain compound interest. It does not consider inflation or investment performance so should not be used to predict the returns of any investment you’re considering.
Always remember that past performance is no guarantee of future performance.
The earlier you start your pension the better
As you can see, giving your pension pot as much time as possible to benefit from compound growth could increase its value significantly. Indeed, the difference could make the difference between being able to afford the lifestyle you want in retirement, or not being able to.
That’s why speaking to a financial adviser as early as possible is usually a very savvy decision, even when retirement seems a lifetime away. Not only can a financial adviser help you to maximise the growth potential of your pension pot, they can ensure that you’re doing so in the most tax-efficient way.
If you would like to learn more about the tax relief offered by pension schemes, and other simple but important facts you need to know, please read our recent blog.
Get in touch
If you’re thinking about planning for your retirement or would like to discuss pensions, please get in touch. We can help you understand whether your private or workplace pensions are on track to provide the standard of living you want when you retire, and if not, how to get them back on track.
If you would like to discuss how we could help you, please call us on 01527 577775 or speak to one of our advisers, as we’d be happy to help.
Tuesday 10 September 2024