Three common pension questions answered
For many of us, just thinking about our pensions is enough to bring on a cold sweat. However, pensions aren’t as scary (or as boring) as they first appear. Let’s start by getting back to basics with answers to these three commonly asked questions.
I’m paying into a pension but where does my money go?
So you’ve started to take your pension seriously. You’ve already worked out how much you are willing to set aside for your pension contributions each month. Now what? Where does your money disappear to?
Your money gets put into a pension scheme which is linked to your workplace and managed by a pension administrator. Within this pension scheme your money will be invested in a fund. If you do not engage with this process, a default fund will be selected for you.
So, do I need to do anything or should I just let the money sit in the fund?
The default fund selected for you will not necessarily generate the biggest return. That risk/reward decision is down to you. You can change that fund if you want to, for free.
You may want to choose a fund that has a lower annual charge (meaning you keep more of the return for yourself) or a fund that is riskier (though there is more of a possibility you could lose money) because you like the sound of potentially greater returns. Whatever your reason is, you can have a say in how your money grows.
Surely I don’t need to worry about this now - can’t I leave this until I’m older?
No, its generally held that the sooner you start saving the better the potential return.
The money you put in now has a much greater chance of increasing in value than the money you put in later. The reason for this is compound interest. The following example highlights the power of compound interest.
Sarah and her employer contribute £1,000 a year into her pension, from the age of 20 until she’s 65. She chooses a fund that is growing at 5% a year. Taking compound interest into account, by the time Sarah is 65 the £45,000 she has put into the fund has grown to more than £175,000.
Meanwhile, John decides at the age of 50 to invest £45,000 as a lump sum into the same fund. His investment also grows at 5% a year with compound interest. By the age of 65, although John’s contribution to the fund is the same as Sarah’s, his money will only have grown to just over £90,000.
Put simply – the earlier you start planning and the longer you save into your pension, the higher the potential returns can be.
Of course, do remember that the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. If you are unsure as to the suitability of any investment speak to an independent financial advisor.