Think carefully about how action taken now could affect your retirement
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 for.
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.