A house can be a significant financial asset. However, most people don’t realise that with a little planning, their largest financial asset could be their pension. The following talks about saving early and sensibly for later life.
Common knowledge can be misleading. When I go to the coffee shop near the office, I’m asked what beans I would prefer for my flat white. Yet, while it is widely believed that coffee comes from ‘beans’, it actually comes from seeds – we just call them beans because of their appearance.
You sometimes hear that the Great Wall of China is the only human-made object that can be seen from space. However, the Apollo astronauts confirmed that you can’t see it from the Moon. In fact, when you look at the Earth from the Moon, all you can see is a sphere of white, blue and a bit of colour – no evidence of humanity at all.
Another widely held belief is that buying a house is the ticket to financial security. But is this true?
It’s certainly true that millennials are struggling to buy houses (due to drinking too many expensive flat whites made with their favourite seeds, no doubt). But should younger people be worried by that fact?
The maths of retirement – time is your friend
A house can be a significant financial asset, especially when people stop working. However, most people don’t realise that with a little planning, their largest financial asset could be their pension – most don’t start saving for their pension early enough as a result.
Time for some maths…
Let’s take a 25-year-old, earning 10,000 flat whites a year (or £25,000). Helped by their employer, they save 8% of their salary every year into a pension and invest in a portfolio which should return around 6% a year over the long term. By age 30, they now earn £28,000, and buy a property worth £110,000, just under four times their salary. Well-disciplined with their money, they keep saving that 8% every year.
Fast forward to age 65. With the regular pension contributions and portfolio growth of 6% a year, their pension has grown to £432,000! If we assume the house appreciates in line with inflation at 2%, it would be worth only £220,000. Even appreciating at 3% per year, it would be worth only £310,000 – still over £100,000 short of the pension. That is the power of starting early, and letting time and compounding do the hard work. The conclusions are the same whether you earn £100,000 or £10,000 p.a.
The financial services industry tends to give out the message that saving for retirement is all about quantity – to have a better retirement, the only answer is to save a large amount of cash. Actually, this isn’t necessarily the case, as long as you start early enough.
Start saving early …
We can see this if we change the example a little. Back to our saver. Let’s assume they stop saving into their pension after 20 years, at age 45. Twenty years’ worth of contributions mean that this pot will still go on to reach a respectable £281,000.
But if they wait until 45 to think about their pension, things don’t look so good. Although they’ll be putting away a larger cash sum each month (8% of a higher salary), they will end up with only £130,000 by the time they retire. Their pension is only exposed to growth for 20 years, versus the 40 years for the saver who stopped at 45. So, although the early saver contributed less cash to their pension, they’ve ended up better off than the late-starter.
Unfortunately, many savers in the UK leave saving into their pensions late, often because they’ve focussed on saving for a house, rather than for their future.
For younger generations, the key point is the difference that starting early can make. Of course, this is also relevant to any parents or grandparents who may be thinking of how they can help their children or grandchildren find their financial feet. Even if it’s not explicit financial help, the right advice and good habits can go a long way.
It’s a question of saving smarter, rather than simply saving more. When you are young and your pension pot is smaller than your salary, your savings matter more than your returns. 1% of your salary is more money than 1% growth in your investment.
Saving for a deposit is likely to be the number one priority for many young people. However, if this is at the expense of saving nothing for their pension, they may be doing themselves a disservice.
We all need somewhere to live and the idea of one’s own home can be an emotional aspiration as much as a financial one. Young people already saving into a pension (and their grandparents) shouldn’t be scared, though. They will likely finish up with a much bigger financial asset than those who prioritised buying a property.
Periodically it pays to review what you have managed to set aside to your pensions so far and to see what this will provide for you and family in later years when you want to stop working. Others could look at retiring early and what would be the cost of retiring earlier than the current state pension age of 66, by seeing how well the plans you started out with are working for you.
We will always be pleased to help solve a financial problem, it’s what we do for all our clients.
Thank you for reading this article. My Name is David Rackham one of the Temple Wealth Management Advisers. You can contact me on 07734 172681 where we will always be pleased to assist with your financial concerns.
This article is replicated by kind permission of the Personal Financial Society.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). Please remember that the value of investments (and the income they generate) can increase as well as decrease in value over time. Past performance is not a reliable indicator of future performance. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.