How compound interest works
The short answer
Compound interest is interest paid on interest. Each time interest is added, the next lot is worked out on a bigger balance, so savings grow faster the longer they’re left. £10,000 plus £200 a month at 5% for 20 years grows to £109,333: £58,000 paid in and £51,333 of interest. Time does most of the work, which is why starting early matters more than the rate.
How it works
With simple interest, £10,000 at 5% earns £500 every year. With compound interest, the £500 is added to the balance, and next year’s 5% is worked out on £10,500. The first year earns £500, the tenth £776 and the twentieth £1,263, all from the same £10,000.
Three things decide how much it grows:
- The rate. A higher rate grows faster, but the effect builds slowly: 5% doubles money in about 14 years, 7% in about 10.
- Time. The longer it’s left, the more of the balance is interest, until the interest earns more each year than you pay in.
- How often interest is added. Monthly is slightly better than yearly, because each month’s interest starts earning straight away.
Worked example
£10,000 to start, £200 at the end of each month, at 5% a year added monthly:
| Left for | Paid in | Interest | Balance |
|---|---|---|---|
| 5 years | £22,000 | £4,435 | £26,435 |
| 10 years | £34,000 | £13,527 | £47,527 |
| 20 years | £58,000 | £51,333 | £109,333 |
| 30 years | £82,000 | £129,129 | £211,129 |
In the first five years most of the balance is what you paid in. By 30 years the interest is more than half as much again as everything you paid in.
Starting early
£200 a month at 5%, until 65:
- From 25 (40 years): £96,000 paid in grows to £305,204.
- From 35 (30 years): £72,000 paid in grows to £166,452.
- From 45 (20 years): £48,000 paid in grows to £82,207.
Starting at 25 instead of 35 means paying in £24,000 more, and ending up with £138,752 more. The extra ten years at the start do more than any amount paid in later. In a pension, tax relief and an employer’s contributions add to this; the pension calculator shows them.
Yearly, monthly or daily
Accounts add interest yearly, monthly or daily, and the same rate grows a little differently. £10,000 at 5% for 10 years:
| Interest added | Effective rate | After 10 years |
|---|---|---|
| Yearly | 5.00% | £16,289 |
| Quarterly | 5.09% | £16,436 |
| Monthly | 5.12% | £16,470 |
| Daily | 5.13% | £16,487 |
The difference is small. To compare two accounts fairly, look at the AER (annual equivalent rate) each one quotes, which allows for how often interest is added. The calculator shows it as the effective annual rate.
Taking money out
Compound interest works on a pot you draw from, too. £100,000 at 4% earns about £333 a month to start with, so taking out less than that each month means the pot never runs out. Take out £600 a month and it runs out in the 21st year; £400 a month lasts about 45 years.
What it doesn’t include
Inflation. £109,333 in 20 years’ time won’t buy what £109,333 buys today. If prices rise 2% a year it’s worth about £73,578 in today’s money. The inflation calculator shows how prices have moved in the past.
Tax. Interest outside an ISA counts towards your Personal Savings Allowance: £1,000 a year for basic-rate taxpayers, £500 for higher-rate and nothing for additional-rate. Above it, savings interest is taxed at your rate, and from April 2027 those rates are due to rise by 4 points, to 24%, 44% and 49% (announced, not yet law). An ISA keeps the interest tax-free: you can pay in up to £20,000 a year, and all of it can go into a cash ISA. A plan to cut the cash ISA limit to £12,000 from April 2027 was dropped at the 28 October 2026 Budget.
Investment returns that vary. A savings account’s rate is set by the bank. Shares and funds go up and down, so a steady 5% a year is an average, not a promise.
Work it out with your own figures
See what your own savings could grow to, with regular payments in or out.
Open the Compound Interest CalculatorNext step: see what the money will be worth once prices have risen.