Skip the Coffee: Here’s What £3 a Day Does to Your Pension

How much difference can one coffee a day really make to your wealth and financial well-being? If you put it into a jar on your sideboard, not very much. But if you look at how interest growth and tax relief work on a pension and dive into the wonders of compound interest, it turns out that coffee can do a lot for you. 

For this, we’re going to ask you to skip one flat white per day. That’d cost you around £3.00. 

£3 per weekday. So let’s call it £15 per week, £60 per month. All clear on the maths so far? Good.

Open up the mynestegg pension growth calculator for this one. It’s going to be useful. 

When is £3 not £3? When it’s subject to compound interest

Compound interest is nothing less than a financial miracle. If you put £3 into a bank account, you’d expect to earn interest on that £3 every month, right?

Right. Sort of.

You’ll also earn interest on the interest.

So in month one, you’re earning interest on £3. In month two, you’re earning interest on £3, PLUS whatever interest you earned in month one.

By month 12, or 120, you’re earning interest on far more than your initial three pounds.

How much? Well if you put that £3 into an account with a standard Bank of England interest rate, your money would double in 15 years - even if you never, ever add to it again.

But that’s not how pensions work.

How does interest work on a pension?

Here’s the thing. Pensions don’t usually receive interest. Not in the same way your bank account does. Because your pension pot is very rarely invested in cash, interest isn’t the real factor. Growth is. 

Your money is invested into the stock market to try and grow faster than interest rates over the medium to long term. And as it grows, that growth is re-invested. You earn growth on growth. It’s the same principle as compound interest, but in the right conditions, it can work even better.

How much better? Well, since 2008, the UK interest rate has consistently been below 6% - with the lowest base rate in 300 years. The average interest rate in this period has been less than 1%.

Over the past 25 years, the S&P 500 (that’s the 500 biggest companies in the USA) have delivered an average annual growth rate of 7.8%. 

But how does that growth grow your pension?

With a pension, you’re constantly investing. Every month, you add a little more in.

In year one, all the money you’ve invested grows by a certain percentage. 

In year two, the money you invested grows again - and so does that growth from year one.

So by year ten, you should be seeing growth on the money you’ve invested over a decade. And on all of the returns you’ve seen year on year. Which are hopefully getting higher and higher because your return each year also adds returns from every previous year.

It’s a snowball effect. And it makes three things really clear.

1. You should start a pension as early as you can. Saving for forty years gives you forty years of returns to re-invest and deliver even more growth.
2. You should contribute regularly. Consistency is key here, as it helps that snowball roll faster and grow bigger.
3. Small extra contributions can start to grow significantly over a longer period of time.

How small? Well, that cup of coffee you’re skipping. That £3 every weekday. Let’s crunch the numbers.

Let’s look at the numbers

We’ll keep this as simple as possible. After all, you’ve not had your daily cup of coffee today, right? Because you’re saving that £3.

• Let’s say you’re 22.
• And let’s say you earn the average age for a 22 year old - £22,932 per year.
• And you’re going to retire at 68.

(If those numbers don’t work for you, use our pension calculator to see what changes at your age and wage)

Now let’s talk contributions. Stick to your coffee, and you can afford to put away £100 per month. With no sacrifices.

Skip that coffee and you can put the extra money you saved in.

What will that do to your pension pot?

Before we share the numbers, let’s just give you the context for this. We’ll assume you’re retiring at 65 and getting 20% tax relief on all your contributions. We’ll assume a growth fee of 5%, and account for 0.68% annual fees. And that you’ll increase your contributions by 3.5% per year as your wages change. Finally, we’ll divide up that yearly income to pay you until you’re 100 years old. 

Basically, these are round numbers that will give you an indication of growth - we can’t carve the numbers in stone and say “each coffee skipped WILL deliver X% growth.”

Wow. Skipping that coffee could be worth an extra £11,353 a year to you.

That’s basically ten cups of coffee - and we’re talking venti, not grande -  every single day in retirement. Including weekends. 

We hope you’ve set aside a few Netflix series to watch, because it doesn’t look like you’ll be getting much sleep!

But that’s the power of compound growth, small sacrifices and saving into your pension.

Skipping the avocado toast and the daily flat white won’t buy you a mansion and a sports car by the time you’re 25, no matter what the papers say.

But even small sacrifices like that could lead to thousands of extra pounds every single year in retirement. Or retiring years early.

Maybe that’s the pick-me-up you need in a morning? 

Skip the coffee. Plan for your pension!

We’re always looking to make saving simpler. To learn more about how to set goals, save for the future, or choose the right pension or ISA, visit the mynestegg Knowledge Hub.