It’s said that Albert Einstein dubbed ‘compounding’ as the eighth wonder of the World. While it may be a phrase you’re not overly familiar with, compounding has the potential to significantly boost the value of your pension, and with it, your standard of living in retirement.
As part of Pension Awareness Week, read on to find out more about this little-known concept, and how it could help your pension achieve greater levels of growth over time.
Compounding exposes existing growth to future potential growth
When you place your money into a pension scheme, it’s normally invested into a range of assets such as shares, bonds and cash. With compounding, any growth the assets do make is then exposed to future growth potential as long as the returns are reinvested into the pension pot.
To demonstrate this, you might want to consider the following example. If you use a compound growth calculator, you will see that if your pension’s value was £100,000 and it grew by an average of 3% a year, you would have £103,000 at the end of the first year.
Assuming that you do not take any money out of your pension, or make additional contributions, the growth in the following year will be based on £103,000, meaning it increases to £106,175 at the end of year two. If you remain invested for 10 years, your initial £100,000 would be worth £134,392due to the power of compounding.
By comparison, if you had £100,000 in a bank account that received 3% in simple interest, you would have received £3,000 every year, totalling £30,000 at the end of the 10 years. This means that compounding has increased your returns by nearly £4,935!
Furthermore, after 20 years the effect of compounding means that your £100,000 pension pot could have grown by more than £82,000 – providing a £22,000 uplift to your money’s growth when compared to simple interest.
With compound growth, the longer the better
As you can probably tell, the longer your pension is exposed to compound growth the greater the potential returns. As such, the earlier you start to contribute to a pension scheme the better.
This is even more important when you consider an article published in This is Money, which reveals how long it takes for compound growth to reach a very important ‘tipping point’. This is the point at which the level of growth your pension has made is equal to, or more than, the amount of pension contributions you’ve made.
According to the article, if you invested £250 a month with an average return of 5% a year, after 26 years your pension would be worth £160,229, however you would only have contributed £78,000. As this is 105%, it means the value of your returns would be more than the amount you contributed.
More than this, when you take tax relief on your contributions into consideration, the compound growth on your £78,000 skyrockets to £204,000 over 26 years – a 160% increase! Please remember that this is only for illustrative purposes and does not consider the effects of inflation. This should not be seen as advice.
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As the above illustrations reveal, over the long-term, compounding could make a substantial difference to the value of your pension when you reach retirement. This in turn could boost the level of income you can then draw from it, which means you could enjoy a higher standard of living when you stop working.
If you would like to plan for your retirement or discuss your pensions, please call 0333 010 0008 and we’d be happy to arrange a no obligation initial meeting with one of our independent financial advisers.
19 September 2025