As more people worry about money and are struggling
financially as a consequence of the coronavirus (COVID-19) pandemic, it’s
likely that reducing or stopping their pension contributions may be an option
to ensure they survive financially.
However, while it might be tempting to cut back on your
pension contributions to have more money in the short term, it can have a
significant impact on your finances and quality of life in the long term.
Before making such a decision to improve current cash flow, it’s important to
understand the impact this could have on future finances.
Suspending pension contributions will reduce the total
amount you’ve saved by retirement. How much it falls by will depend on how old
you are, how much you usually pay in, and how long you suspend contributions
Recent figures suggest that a 25-year-old who suspends
contributions for three years could see a 7% reduction in the total value of their
pension at retirement, assuming they have an average salary and their employer
also suspends contributions.
Lower pension value
How much extra money you’ll receive by suspending your
contributions depends on how much you usually pay in. Let’s say that you’re a
basic rate taxpayer who usually makes pre-tax contributions of £140 a month. If
you suspend your contributions, you’ll receive more salary but also pay more
tax and National Insurance contributions, meaning you’ll receive approximately
£4,000 extra over three years.
If, instead, you paid this into your pension and received
tax relief, and your employer matched the contributions, a little over £10,000 would
have been added to your pension. This could grow significantly if left invested
until retirement, so you would also lose out on the investment growth.
Damaging income effects
Reducing your pension contributions may seem like a good
alternative. But this will also substantially reduce your pension value,
particularly if you fail to increase your contributions again later.
Permanently reducing your contributions by 1% at age 25 could result in an 18%
drop in retirement income.
If you feel that you have no choice but to suspend your
pension contributions to make ends meet, you should aim to restart your
contributions as soon as you’re able to. The longer you leave it, the more
serious the impact this will have on your eventual retirement income.
Protecting your pension
Cost cutting may be high on the agenda for many families at
the moment and one obvious way to save some money is pausing pension
contributions. But if you would like to discuss alternative ways of improving your
cash flow and protecting your pension, speak to us to review your options.