What to do with your pension in your 20s

Planning for your retirement is likely not your top priority in your 20s. You might be facing hefty university loans, trying to support yourself on an entry-level salary, and figuring out how you want to set up your life. But ironically, your 20s can be the most impactful working years for creating a comfortable retirement.

Thankfully, you can start investing in your pension with virtually no effort thanks to pension auto-enrolment, which leaves more time for figuring out that first decade of adult life.

And with just a little bit more time spent on your investment journey, you can make your pension work even harder for you. Here’s a few quick things you can do to make sure your pension is setting you up for the future.

Taking advantage of auto-enrolment

If you’re part of a workplace, over the age of 22 and make over £10,000 a year, your employer is required to auto-enrol you in a pension programme. At a minimum, you will need to contribute 4% of your salary each year to your pension, and in turn, your workplace will contribute an additional 3%. This will then benefit from a tax relief boost, which would be 1% if you are a basic rate taxpayer.  

Those who choose to opt out of auto-enrolment won’t be getting the contributions from their workplace, or the tax relief.

But if you do stay enrolled, your pension contribution is essentially automatically doubled through these other contributions. That’s a great start on any investment.

If you don’t have an employer, you can instead invest through a Self-invested personal pension (SIPP). While you won’t be getting the top-up from work in this scenario, you still can get the tax relief. It’s important to note that if you want a SIPP, this won’t be automatically done for you like it would be in a workplace. Instead, you will need to set one up yourself.

What difference does investing early make?

If you start investing at the beginning of your career, you can take full advantage of the snowball effect of compound interest. Because your money has a much longer time horizon, it will start to grow exponentially. This is how it works:

Let’s say two employees, Sally and John, both start at a job at 25 years old on a salary of £35,000. Sally decides to keep her money in a workplace pension, but John opts out, because he wants a bit more spending money, and figures he can just invest more once he’s promoted.

Thanks to workplace contributions and tax relief making an overall contribution of 8%, Sally will be building up £2,800 in her pension each year. John will take home an extra £1,260   each year but not make any contributions.

By the time they are 35, Sally and John have had their salaries raised by 2% each year and now make about £42,666. John decides he’s now ready to begin paying into his pension. But how much will he need to catch up with Sally?

Sally would have saved about £39,296 into her pension by 35. And if she retired at 65, that would turn into £472,863, assuming an annual return of 5% after fees. If John did the same minimum investment, but started at 35 instead of 25, he would have £297,260 by 65, over £150,000 less. To match Sally’s pot, John would have to increase his contributions from 8% to 13%.* While he’d still get tax relief on the extra contributions, he wouldn’t necessarily get more help from his employer, so this could mean he needs to invest over double the amount from his own pocket to make up for lost time.

Investing your pension

You may be able to boost your pension returns even more by picking the right investments. If you’re auto enrolled in a pension, an investment will have been chosen for you. However, depending on your goals, it may not meet your exact needs. Some of these plans have a more cautious approach to investing, and since you likely have over 30 years of investing ahead of you, you may be more comfortable riding out the volatility than someone who plans to withdraw their money soon.

The other important factor to watch out for is investment fees. Your workplace pension for auto-enrolment is not allowed to charge more than 0.75% a year of the total value of your pension pot for investing in the default fund, though many schemes will come in well below this fee cap. In some cases, it may be possible to get pension fees that are lower than your workplace scheme, which can mean a difference of thousands of pounds in your pot overtime. You may therefore wish to transfer your pension to another provider after you have left that particular job and are therefore no longer receiving contributions from your employer.

If you have a SIPP instead of a workplace pension, you’ll choose your own investment from the get-go. SIPPs typically have a much broader range of investment options than workplace pensions, which can be advantageous to those who would like to make their own investment decisions, or invest in assets like individual stocks and bonds.

If you have a SIPP but don’t want to make your own investment decisions, there’s no need to worry. There’s still a large number of tracker funds, ETFs, or ready-made options that you can choose from to simplify the process. Just make sure you’re comfortable with the level of risk you’re taking and have a look at the fees.

*All calculations by AJ Bell assuming salary sacrifice pension scheme