Compound interest can transform £35,000 of contributions into a £100,000 pension pot, with investment growth accounting for the majority of the typical fund, according to new research from retirement specialist Standard Life.
The analysis of government figures found that investment growth accounted for around £65,000 of a typical £100,000 defined contribution pension pot, or 65%. Individual contributions accounted for £18,000, employer contributions £13,000 and tax relief £4,000, totalling £35,000, or 35%.
Most people underestimate compound growth
Two-thirds of a typical pension pot comes from compound growth, but three quarters of people do not realise it. Many more thought their own contributions made the biggest difference.
Compound interest is the process where you earn interest on the money you originally put away, then even more interest on the interest you have previously earned. It keeps compounding year after year, in what is called the snowball effect.
Starting early makes a significant difference
Jenny Holt, customer savings & investment director at Standard Life, said compound investment growth is one of the most powerful forces in pension saving. She added: "Contributions are important, but the real benefit often comes from giving them time to grow and generate returns over decades."
Standard Life found that someone starting work at 22 on a £25,000 salary and paying minimum auto-enrolment contributions of 5% and 13% from their employer could build a £210,000 retirement fund by age 68, adjusted for inflation. These figures assume 3.5% annual salary growth and an average total investment return of 5% a year after charges.
Waiting five years until 27 to get started reduces the projected pot to £170,000, a shortfall of £40,000.
Delaying can mean missing out
Holt said modest contributions made earlier in your working life roll up because they have longer to benefit from compound investment growth. She added: "Delaying can mean missing out on the years when your money could have been working harder for you."
Investment returns are not guaranteed, but the earlier you start, the longer your money has to overcome short-term stock market volatility.
