Why you’re richer than your parents and don’t even know it

Richer than your parents

Written by Nick Green from Unbiased.

You – yes, you – are richer than your mum and dad. Of course you know what I’m going to say next: ‘True wealth isn’t about money or material riches, but about youthful hopes and dreams and potential and creating a better, brighter world.’ And you’d be wrong! I’d never serve you up something like that. This is absolutely about material riches. We are talking money.

At this moment, you have wealth (actual £££s, remember) stored up that your parents can only dream of. You know the expression ‘Time is money’? Well, in this case that’s not a metaphor. Because when you’re building up a pension, the link between time and money is about as literal as you can get.

Wait – did you say pension?

Yes. Still reading? You should be. When you’ve not even started your career yet, it may seem counterintuitive to think about planning for retirement. But the fact is that there will never be a better time in your life to do so. You may have nothing in the way of income now, and you expect to struggle financially for some years to come. However, what you do have is lots of time. And although there will come a day when you earn more money, you will never accumulate any more time. So isn’t it time you started using it?

You may not realise quite how well time can be spun into money by the magic dwarf named Rumpelpension. So here’s a demo.

A very interesting story

Once upon a time there was a brother and sister. Emma started a pension aged 20, investing just £50 a month. Her brother Xavier (don’t ask) decided it wasn’t worth it until he earned more, so he waited until he was 40. However, he then invested £100 a month in order to catch up.

Now, every time Emma paid £50 into her pension, she found that the balance actually went up by £62.50. Why did that happen? Because contributions into a pension receive tax relief, so the money is treated as if you’d never paid income tax on it. Emma, a basic rate taxpayer, was normally taxed at 20 per cent. And £62.50 taxed at 20 per cent is £50.

However, brother Xavier had another advantage over her. Because he earned over £43,000 he paid some income tax at 40 per cent – which meant he received double the tax relief on his pension contributions. So every £100 was transformed instantly into £166.

Both their pensions grew at the same rate, 4 per cent. So how much richer than his sister did Xavier end up?

Twist ending alert…

To recap: Xavier paid in £100 a month (which became £166 through 40 per cent tax relief) from the age of 40, while earning 4 per cent interest a year. By the time he’s 60, his pension pot is worth around £60,600. Given that he paid in only £24,000 of his earnings, that’s not too shabby.

But what about his sister, Emma? She contributed £50 a month (boosted to £62.50 through 20 per cent tax relief) and earned the same 4 per cent interest a year. She invested exactly the same amount as her brother (£24,000) but over 40 years rather than 20. So by the time she’s 60, she has more than £72,800 in her pension pot.

Against all expectations, Emma wins. How did that happen?

The magic of compound interest

The one thing Emma had on her side was time. Although she paid in the same total amount as Xavier (and received only half the tax relief) she did so for twice as long. This resulted in a much longer exposure to compound interest. Every penny of interest that Emma and Xavier earned went on to earn interest of its own, in a snowball effect. But Emma was essentially rolling her snowball twice the distance, so it ended up growing much bigger despite her disadvantages.

There will never be a better time to do it

These figures are just examples – in real life, you should eventually be paying more than £50 a month into your pension, and if you have a workplace pension then you may also receive contributions from your employer. All of this helps you build up a large savings pot for your retirement. But as you’ve seen, nothing makes such a dramatic difference as the length of time you pay into your pension.

Understandably, a pension may be the last thing on your mind when you leave university. Life will throw countless other expenses at you, from renting a home to running a car to saving up for a place of your own… and you can’t imagine being retired. But consider this. The time you have on your side right now is effectively free money in the bank. If you were to start your pension this week, even saving just a few pounds a month, you could use that invaluable resource that is otherwise going to waste.

The benefits of starting a pension early will kick in long before you’re near retirement. It can mean, for instance, that you have more money to spend in your 30s and 40s, because with a decade or two of saving behind you, you may not need to make such large pension contributions at that stage.

It’s a safe bet that your parents wish they had started their pensions sooner. Not many people fully grasp the truth of the statement ‘time is money’ – but now you do.

So what are you going to do about it?

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