How putting off starting a pension for just five years in your 20s can cost you tens of thousands

Putting off starting a pension for five years in your 20s can create a £40,000 hole in your savings, new research reveals.

A young worker aged 22 on £25,000 a year, who is auto-enrolled into a pension and sticks to saving through their working life could expect to have £210,000 by age 68.

But the same fund would reach only £170,000 if you opted out until you were 27, and £135,000 if you waited until you were 32.

That is based on minimum saving levels under auto enrolment - although if you put in more, many employers will increase their contributions too.

The figures take into account pay rises, investment growth, charges and inflation over the years.

Those who join a pension later miss out on the power of compound growth, which is hugely beneficial if you start young because it has more time to work, says pension firm Standard Life which did the calculations.

Compound growth means because any investment return stays in your pot, you then make a return on that higher amount, and then a return on that even larger sum, and so on over and again.

You might start with a small contribution to a pension, but making returns on your returns will still have an exponential effect in the longer run.

If you are older and have already enjoyed the benefits of compound growth, it is worth showing young adults in your life the table from Standard Life below. (You can also tell them the story of Prudence and Extravaganza - scroll down for more.)

Standard Life says young people have to strike a balance between putting money away for the long term, and meeting costs and goals in the nearer term.

It admits pensions might not be on the priority list at that age - but stresses that if you do start early, your future self is likely to thank you for it.

Dean Butler, managing director for retail direct at Standard Life, says: 'If your finances permit and your circumstances allow, the sooner you engage with and begin to contribute to your pension, the better your ultimate retirement outcome could be.'

'While delaying entry into the workforce, for instance to pursue further education, can offer long-term benefits, both financially and personally, it's important to be mindful that this might require you to contribute more later on to meet your retirement goals.

'Similarly, if you choose self-employment in your twenties, it's worth opening a personal pension, as you won't benefit from automatic enrolment via a workplace and could miss out on important early-career contributions.'

Under auto enrolment people are signed up for a pension whenever they start a job, unless they actively opt out.

The minimum contribution is 8 per cent of your earnings that fall between £6,240 and £50,270. But this is split three ways, with you putting in 4 per cent, your employer contributing 3 per cent, and the Government adding 1 per cent in tax relief.

'Albert Einstein called compounding the eighth wonder of the world,' says Fidelity International investment director Tom Stevenson.

To illustrate its power, Stevenson tells the tale of sisters Prudence and Extravaganza in his guide to compound growth for This is Money.

Prudence starts saving £20 a week when she is 18 which gives her £1,000 a year. A combination of capital growth and dividend income gives her 10 per cent a year, plus she adds in a new £1,000 each year too.

'By the time Prudence is 38 she has accumulated £63,000 and now the extra £1,000 a year of saving starts to become irrelevant. By the time she is 60, she has accumulated a little over £500,000 even if she stops saving completely at the age of 38.'

Extravaganza spends the years from 18 to 38 enjoying herself and not saving anything, but at 38 she sees her sister's success and starts saving £20 a week and earning the same 10 per cent.

She never catches up.

'When they are both 60, Extravaganza has accumulated just £80,000 compared with her sister's half a million. And with every year that passes their fortunes diverge even further.'

Dean Butler of Standard Life offers the following tips.

1. Make sure you're taking advantage of all the benefits of your pension plan and of the pension support offered by your employer.

If your employer offers a matching scheme, for example, where if you pay additional contributions they will match them, consider paying in the maximum amount your employer will match to get the most out of it.

2. Getting a bonus this year, or receiving overtime pay? Deciding to pay some or all of your bonus into your pension plan could save you paying some big tax and National Insurance deductions, meaning you could keep more of it in the long run.

Similarly, if you're working overtime and you're able to direct some of your overtime pay into your pension, even relatively small extra contributions can build up over time.

If you're able to, think about paying a little more into your pension when you get a pay rise or have a little extra savings.

3. Keep an eye on your investments, the returns they're giving you and whether they match the level of risk you're comfortable with.

Higher-risk investments potentially see more growth over the long term, but their value might go down and up more frequently and dramatically.

Lower-risk investments, like particular types of bonds, are less likely to see drastic decreases in value, but you might not experience particularly significant growth with these.

In your 20s, you might feel happier with some higher-risk investment, as your pension has more time to potentially recover from dips in the market – but this won't be right for everyone.