Beware: the long-term cost of pausing pension contributions could run into thousands

With inflation at a 40-year high of 10.1%, the cost of living crisis may mean that you are looking at ways to reduce your outgoings.

In fact, according to a report published in the Independent, 93% of people have already noticed the effects of rising costs and inflation on their personal finances.

For those whose retirement is still some time away, one cost that you may have in your sights could be your monthly pension contribution. However, while this sum may seem like low-hanging fruit that does not matter right now, ceasing payments could prove to be a costly mistake when you retire.

Read on to learn why you should resist the temptation to stop or reduce the contributions you are making to your pension.

Stopping pension contributions can shrink your retirement fund

Because short-term changes can have a lasting effect on your long-term financial plan, it is important to consider every possibility before rushing into any decisions.

For example, pausing your workplace pension contributions for just a year in the face of current pressures could leave you thousands of pounds worse off in retirement.

Consider this: someone who started working with a salary of £25,000 a year who paid the minimum contributions from age of 22 could end up with almost £457,000 in retirement. However, if they decided to pause contributions for just one year at age 35, they could end up with nearly £13,000 less than if they had continued contributions at the same minimum level.

Of course, stopping contributions for a longer period would have a greater negative effect on your retirement pot, as demonstrated in the chart below.

Total retirement fund at age 68, for someone who starts working at age 22 on a £25,000 salary, paying 3% contributions into a workplace pension:

Source: Standard Life

Cutting contributions means missing out on valuable tax benefits

Pension contributions are typically given tax relief at source. This relief is applicable on all pension contributions up to your Annual Allowance, which for the 2022/23 tax year stands at £40,000 (or 100% of earnings, if lower).

Paid at source the basic rate of 20%, for every £100 you contribute to your pension, you are effectively only paying £80, with the other £20 being added by the government. Higher- and additional-rate taxpayers can claim further relief of up to 20% or 25%, respectively, through self-assessment.

Non-earners can also contribute £2,880 a year. With the tax relief added, this means non-earners can benefit to the tune of £3,600 a year.

If you decide to pause your pension contributions, for any amount of time, you will also miss out on the valuable tax relief.

Do not dismiss the potential value of investment growth

The other major problem of reducing or stopping your pension contributions is that you will also lose the even greater potential returns that your pension fund might generate over the longer term.

Pensions are, by their nature, long-term investment vehicles that benefit greatly from the effects of compound growth.

Over time, your regular pension contributions, especially those maintained from an early age, should achieve significant compound growth.

Read more: The power of compounding and how it helps grow your wealth

This growth can make all the difference to the amount of income you have to live on during your retirement years. Reducing or pausing pension contributions years or even decades before you retire could mean sacrificing substantial long-term returns.

Seek alternative ways to reduce costs

Since April alone, the energy price cap has increased by 54% and is expected to do so again, by another 65%, in October 2022.

This, along with higher National Insurance contributions (NICs) and, of course, inflation, is naturally going to take a toll on many people’s finances.

Wherever possible, the first thing to do when trying to reduce costs is to look for areas where you can decrease your spending. Perhaps you could cut back on unnecessary purchases or shop around for better deals.

A recent survey from Standard Life revealed those areas where most people were looking to make savings:

  • 51% of people would opt to reduce the amount of energy they use
  • 51% would cut down on luxuries
  • 30% would have meals out less often
  • 23% would cancel some of their subscription services
  • 23% would take fewer holidays.

Get in touch

At Bowmore Financial Planning, we have years of experience in helping clients make the right choices for their money. If you are concerned about the rising cost of living and what this means for your current and long-term financial plan, get in touch.

We will look at your entire financial situation and provide you with advice that suits your specific circumstances. Email enquiries@bowmorefp.com or call 01275 462 469 to find out more.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Workplace pensions are regulated by The Pension Regulator.

The Financial Conduct Authority does not regulate Estate Planning or Inheritance Tax Planning.

Bowmore Financial Planning Ltd is authorised and regulated by the FCA.

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