A recent Money Marketing report suggest that 25% of us reduced our pension contributions this year. Some stopped contributing altogether.
Around ten million workers have been furloughed since the Job retention Scheme was introduced, with around two million still on 80% of their normal salary at the end of October.
Struggling to make ends meet, it is men and young adults who are most likely to have stopped pension contributions, but a short break at any age can have huge long-term consequences for your fund at retirement.
Even a small break in contributions can make a huge difference in retirement
According to a recent Money Marketing report, a 30-year-old earning £30,000 and making minimum pension contributions (8%) could retire with £45,000 less after a three-year pension holiday.
For a 50-year-old earning £100,000 and contributing 10%, the loss could amount to £70,000 after a three-year break.
Here are three reasons why it’s important to keep contributing if you can, and if not, to restart contributions as soon as you can afford it.
1. You could miss out on the benefits of compound growth
The effects of compounding mean that you benefit not only from the returns on your contributions but on the growth on those returns too.
Contribute £100 into a pension investment earning 5% interest and in the first year, you will earn £5. In the next year, due to compounding, the 5% interest will be based on the new amount of £105. The rate stays the same, but year two’s interest is £5.25.
Over the first few years, the difference might not seem that impressive but over a longer period, and as amounts grow, the effect becomes much more pronounced.
Among those most likely to reduce or stop their pension contributions are young adults. However, the younger you begin saving into your pension, the greater impact the effects of compounding can have, and the more potential growth you are potentially missing out on.
Starting to save for retirement early is important. It has an impact on the size of your pension fund at retirement for several reasons. You can make more contributions, possibly take greater risks, and benefit from the effects of compound interest.
2. You don’t want to miss out on your employer’s contribution
Stop contributing to your workplace pension and you’ll stop receiving your employer’s contribution too. You’ll be missing out on a ‘free’ pension top-up.
Auto-enrolment arrived in 2012 as part of a government plan to incentivise retirement saving. According to The Pensions Regulator, between 2012 and 2018 the proportion of eligible staff saving into a workplace pension increased from 55% to 87%.
The minimum auto-enrolment contribution for the 2020/21 tax year is 8% of qualifying earnings. Your employer contributes a minimum of 3%, and you pay 5%.
Qualifying earnings for the tax year means any pre-tax income from your employment between £6,240 and £50,000. If your pre-tax salary is £24,000, your qualifying earnings are £17,760.
Stopping your contributions for a year on this salary would see you miss out on £532.80 of employer contributions. This is based on an employer contributing the minimum of 3% but some companies might even match the amount you contribute, meaning you’d miss out on even more.
3. You might jeopardise your dream lifestyle in retirement
A Which? report conducted this year looked to calculate how much the average retiree household spends in a year. It concluded that a retired couple living a ‘comfortable’ retirement, spend on average, around £2,110 a month, or £25,000 a year.
If you are looking for a luxurious retirement – including long-haul holidays and a new car every five years – the average spend is closer to £40,000.
Understanding the kind of retirement you want will help you decide the size of your contributions and your desired pot at retirement.
Whatever your plans, the best chance you have of achieving these amounts is to start early, contribute regularly, and take advantage of workplace contributions.
Restart contributions as soon as you can afford it
This year has been tough for many. The threat of redundancy, the reality of reduced pay, and the forced closure of your business throughout lockdown might have led you to reduce or halt pension contributions.
Even a short gap in contributions can have a massive impact in later life, detrimentally affecting your lifestyle in retirement. If you’ve reduced or stopped contributing, the sooner you restart at your full amount the better.
Get in touch
Speak to us and we can help you formulate a plan to get back on track.
Please contact us if you’d like to discuss your retirement and we can help put a plan in place that works for you. Please email info@investmentsense.co.uk or call 0115 933 8433.
Please note
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of, and reliefs from taxation may change in subsequent Finance Acts. The Financial Conduct Authority does not regulate tax advice or estate planning.
