How to use the power of compound interest to save for your retirement
If you were looking for a reason to start investing for your retirement now (or to invest more), here’s a compelling one: compound interest.
The genius Albert Einstein famously described compound interest as “the eighth wonder of the world.” He also wisely noted: “He who understands it, earns it … he who doesn’t … pays it”.
And if that doesn’t make you curious to learn more about the power of compound interest, then perhaps knowing that Warren Buffet, one of the most successful investors of all time, credits it as a reason for his wealth will help!
Now, while not everyone can hope to amass the billions earned by Warren Buffet from investing, if you have money available to save or invest – especially in a pension – you too could benefit from the ‘wonder’ of compound interest.
In this article we’ll explore exactly what compound interest is, why it’s so powerful, and what it can mean for your own savings and investments – particularly your pension.
What is compound interest?
Compound interest is the interest calculated on the principal (amount you have invested or borrowed) AND on the interest you have accumulated to date.
Compound interest is different to simple interest, where interest is not added to your principal when calculating the interest during the next period (usually a month or year). Simple interest is usually applied to loans, but is also used on some savings accounts.
Here’s how the two types of interest are calculated:
- Simple interest: To calculate simple interest you multiply your initial investment by the interest rate and then by the term of your investment or loan.
- Compound interest: With compound interest you also earn interest on the interest you have already earned from your investment.
Why compound interest is so powerful
The great thing about compound interest is that you don’t need to do anything to earn it… other than leave your money invested! And the longer you leave your money in an account that earns compound interest, the more chance it has to grow.
It also means that the earlier you start saving – for example into a pension – the longer compound interest has to build up. This is why it’s a good idea to start putting something away, even if you can only afford a small amount, as soon as possible.
Another great thing with investing in a pension, is that not only will you earn compound interest on your own money, but you can also earn it on any contributions your employer pays in, or on any top up you get from the government.
And don’t forget, if you have a limited company, any contributions you make to your pension through it could be treated as an allowable business expense, and may be offset against your corporation tax bill. There are also benefits to paying into a pension if you are self-employed.
Because compound interest accumulates over time, it can turn a small amount of savings or investment into a significant amount. And the great thing about it is that it grows for you while you are living your life. You can forget about it, knowing that it is helping to increase your savings or pension.
An example of compound interest
Here’s an example of how compound interest can work. Let’s say you invest £1,000 into a pension fund with interest growth of 5% per year. Here’s what you’ll earn:
- In year 1 you’ll earn £50 interest
- In year 2 you’ll earn £102 interest
- In year 3 you’ll earn £158 interest
- In year 4 you’ll earn £215 interest
- In year 5 you’ll earn £276 interest
In total, you will earn £801 interest over the five years. If you were to keep investing £1,000 a year for 20 years, with interest growth of 5% per year, you would have £35,188. That’s £15,188 earned in interest in total.
Here’s what that growth looks like:

Use our compound interest calculator
To give you an idea of how much your own money can grow, check out the compound interest calculator. Just add in the amount you have invested (or plan to), the interest rate, and how often interest compounds (monthly or annually), and the compound interest calculator will tell you how much your investment can grow – up to 40 years:
The earlier you start saving into a pension the better
The long-term growth of compound interest works perfectly for pensions, where you save over many years (or decades) for your retirement.
It also means that it’s important to start saving into a pension as early as you can – even if you can only afford a small amount. Equally, the longer you can hold off from drawing down your pension, the longer you give it to grow. You can currently only withdraw from your pension from age 55, this is rising to age 57 in 2028.
And, as mentioned earlier, it’s not just your own money that can grow for you if you pay into a pension. If you’re eligible for Auto-Enrolment and are contributing to your workplace pension scheme you’ll need to pay a minimum of 5%, and your employer must contribute at least 3% of your qualifying earnings.
Most basic rate taxpayers also usually get tax relief on their pension contributions, which means that the government effectively adds money to your pension pot. Basic rate taxpayers usually get a 25% tax top up from HMRC, which means an extra £25 for every £100 you pay into your pension making it £125, Additional and higher rate taxpayers can claim further tax relief through their Self-Assessment tax returns.
The three golden rules of compound interest
So remember, in order to maximise the benefits of compound interest, try to follow these three golden rules:
- Start early: The sooner you start saving the longer compound interest has to work its ‘magic’
- Contribute often: Small, consistent contributions can add up to significant growth in time
- Be patient: The longer you can leave your money, the more chance it has to grow
Check your retirement savings with PensionBee’s Pension Calculator
If you’re not sure how much money you need to be saving for your retirement, check out PensionBee’s Pension Calculator. Here’s how it works:
- Set yourself a retirement goal, and thinking about how much you’d like to (or need to) receive for each year of your retirement
- Enter your current age and the age you plan to retire
- Share the value of any pensions and savings you already have
- Decide how much you’d like to pay into your pension each month or year, then adjust the amount until you reach your retirement goal
As a rough rule of thumb, it’s recommended to save around 15% of your salary when contributing to your pension. However, this will depend on how old you are and when you plan to retire and how much you’d like for your desired retirement income. The closer you are to retirement when you begin saving, the more you’ll need to save.
There are limits on how much you can contribute to a pension per year while still claiming tax relief – known as the annual allowance. For 2024/25, the annual allowance is 100% of your salary or £60,000 (whichever is lower).
If you want to retire early, you can access your personal or workplace pension from age 55 (rising to 57 from 2028), but this means you’ll need to save significantly more in a smaller time frame.
Risk warning: As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.

About PensionBee
PensionBee can help you combine your old pension pots into one easy-to-manage online plan that lets you keep track of your balance, make flexible contributions, invest in line with your values and make withdrawals from the age of 55, rising to age 57 in 2028. For more information, visit PensionBee.
Learn how long your pension could last with the PensionBee Pension Calculator.
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