If I told you that if you gave me £100, I would turn it into £225 immediately would that sound like a good deal?
It’s certainly very tempting. So tempting, in fact, that I’d advise most people offered this kind of instant bumper return to say ‘thanks but no thanks’ as it would probably be a scam.
Except, this example isn’t some get rich quick scheme that just leaves someone else richer at your expense.
Instead, it’s a get rich slow scheme that requires a lot of patience but can seriously pay off, especially if you start doing it as early as possible.
Have you guessed what I’m talking about? It’s paying money into a pension.
If you have an employer that will match your pension contributions, which some don’t but many of us do, that’s the deal you could get on £100 that you pay in.
It works like this, you pay £100, your employer matches it with another £100, and you get an extra £25 from basic rate tax relief.
The latter is the automatic bump the government gives you on your contribution to take you back to the position that you were in before 20 per cent basic rate tax.
It’s a 25 per cent uplift because at the basic rate level that’s what you need to turn the £80 you get post tax out of every £100 earned back into pre-tax income.
Higher rate taxpayers can claim more tax relief back through their employer or a tax return.
It’s important to explain the mechanics of this, because while to those of us who know our way around personal finance it sounds elementary, many others aren’t clear on what is going on.
What people also need to know is that not all employers match pension contributions and auto-enrolment rules are less generous, so remember the above headline is only an example and check what your scheme actually does.
But to go back to my original point, the ability to turn £100 into £225 is a cracking deal yet this kind of thing somehow tends to get buried when the government and financial industry talks to us about paying into our pension.
Some of that is to do with compliance and the fact that regulated financial firms need to add in lots of caveats and small print in the way that us free-wheeling financial journalists don’t. (This is a massive bugbear for many financial advisers).
And there are some important caveats: the offer’s not unlimited – your employer doesn’t have to match contributions and even if it does it will put a limit on that, and the government caps the amount that can go into your pension and get tax relief (albeit at a very generous £60,000 a year).
The most important pension catch you need to know about though is that you can’t get at the money until you are at least 55 (an age that’s due to rise).
However, on the basis that this is apot to rely on for a comfortable retirement, this is also one of the best features of a pension – you can’t get at the money until you are at least 55.
This can make paying into a pension a tough sell for younger people, but there’s another retirement saving trick they need to know about, which is the magic of compounding.
Compounding involves earning returns on existing returns and creates a snowball effect – as it rolls down hill, the bigger a snowball gets as it gathers snow upon snow.
This is why you should start saving into a pension early.
Our long-term savings calculator shows that if you invest £225 a month into your pension for 30 years from the age of 25 to 65 and get an average 6 per cent return, you could end up with a pot worth £226,000.
But if you invest £225 a month for 40 years, from the age of 25 to 65 and get an average 6 per cent return, you could end up with £448,000.
Considering that £225 might only cost a worker £100, I’d say this is a deal worth taking.
