With the cost of living on the rise, lots of people are looking for ways to lower their outgoings and many are considering whether they should pause their pension contributions. Head of Personal Finance, Brian Byrnes, breaks down what the implications could be long-term and explains some alternative options.
What benefits will I miss out on?
While times are tough, stopping your pension contributions altogether could cause more harm than good. Not only would your pension savings miss out on regular top ups from your contributions, but they’d miss out on a host of benefits that boost your savings with every deposit.
Contributions to your pension of up to £60,000 per year are tax free. Which means that whenever you deposit into your pension, the government tops up your pot with the amount that you would have paid in tax on your earnings.
If you’re a basic rate taxpayer that means you’ll automatically get a 25% top up to your savings and if you’re a higher or top rate taxpayer, you could get even more! (Although you’ll have to claim the additional tax relief).
Pension tax relief makes contributing to a pension one of the most tax-efficient ways of planning for life after work. Plus, it’s free money from the government!
Tax treatment depends on individual circumstances and is subject to change.
Thanks to auto-enrolment, usually when you start a new job your employer will set up a workplace pension for you, which they’re legally obliged to pay into as long as you do too. Typically, employers will contribute a minimum of 3% of your annual salary – with many paying quite a bit more.
You should be aware that if you lower or pause your contributions, your employer could too.
National Insurance contributions
If your pension deposits come directly from your salary, you’ll pay National Insurance on these contributions. In order to receive any State Pension, you’ll usually need to have 10 qualifying years on your National Insurance record.
The third stream of free money for your pension is compound interest. Described as the ‘snowball effect’, this is when any return on investments in your pension generates growth on itself. So, when you pause your pension contributions, you could be missing out on additional potential growth from compound interest.
How will it affect my pension over the long-term?
While you would gain a boost to your income right now, pausing your pension contributions will leave you with less Funds, also called ‘tracker funds’, are financial instruments that have been set up to match or ‘track’ the price of a market index. Investing in a fund lets you get exposure to different financial assets like shares and bonds, without having to buy them directly. later in life when you have less options open to you.
Just as small amounts invested now could grow into something greater in the future, pausing contributions – no matter how small – could have big implications for your retirement later.
Let’s look at an example…*
Eve is 35, earns £30,000 per year and contributes 5% of her salary to a workplace pension, while her employer adds 3%.
Eve contributes £125 (including £25 tax relief)
Her employer contributes £75
Total monthly contribution: £200
If Eve stopped her contributions for one year, she would gain £100 per month to her income (including income tax payment), totalling £1,200 over the year. However, if Eve were to contribute that £100 to her workplace pension, she’d receive tax relief and employer contributions taking it to £200 for her pension savings.
Plus, her contributions for just that year (£1,200) have the potential to grow up to £8,540 in retirement*. In gaining an extra £100 per month now, Eve could potentially lose close to £9,000 in 30 year’s time!
What can I do instead of pausing pension contributions?
We understand that for some people in the current circumstances, something has to give. But there are ways to reduce your outgoings without sacrificing your pension altogether.
Reduce your payments instead of pausing altogether
Instead of stopping your contributions, you could consider reducing the amount you put aside each month. This way, you’ll gain a little extra income but you won’t miss out on all those great benefits – like pension tax relief and employer contributions – that will help your pension pot grow.
Use our handy Pension Calculator to find how adjusting your pension contributions could impact your future pension pot.
Are you missing out on workplace pension benefits?
Many workplaces offer benefits such as pension matching or increased employer contributions – it’s worth asking your employer about their policies on this.
Let’s say your employer agrees to match what you save, you could potentially lower the % you contribute without losing any extra money into your pension.
We get that it can feel hard to prioritise your pension right now, but regularly setting money aside (no matter how little) could have a big impact over the long-term.
Important to know
*Example is hypothetical and figures are indicative – not guaranteed. It assumes that you’ll see a 5% return on your investment each year over 30 years. It also excludes product and investment fees. Contributions are based on gross earnings and include a basic tax rate of 20%.
Payments you make into your pension won’t be accessible until the minimum pension age (currently 55, increasing to 57 in 2028).
If you’re not sure whether the Moneybox Pension is right for you, you may want to contact a suitably qualified financial adviser for help.