The cost of living crisis has affected lots of households over the past year; from groceries to energy bills, it’s likely you’ve noticed at least some of your expenses rising in recent months. Alongside the price rises, interest rates have also risen to their highest level in 15 years, causing mortgage rates to soar. According to a report by Which?, the average two-year fixed rate deal as of 22 August 2023 was 6.75%, compared to 3.95% in August 2022. If you’ve been affected by the increase in mortgage rates, you may have considered how you might reduce your expenses elsewhere to ease pressure on your finances. Indeed, research reported in Mortgage Solutions has discovered that 23% of people would consider reducing their pension contributions if mortgage costs were to put a strain on their bills.
But pausing pension contributions could jeopardise your retirement plans. Even a short pause could create a significant shortfall in your pension fund by the time you reach age 68. Read on to discover why.
Pausing your pension contributions could cause you to have a shortfall of funds when you retire
Even if you only pause your pension contributions for one year, this decision could have a significant impact on the value of your pot by the time you reach retirement.
Research by Standard Life has found that a one-year pause in contributions could leave your pension pot almost £13,000 smaller than it would have been if you hadn’t taken a break. The shortfall increases to £38,000 if you pause contributions for three years.
|Total retirement fund at age 68
|No breaks or reductions in pension contributions
|Stopping pension contributions aged 35 for 1 year
|Stopping pension contributions aged 35 for 2 years
|Stopping pension contributions aged 35 for 3 years
Source: Standard Life. Calculations are based on the assumption that you start work with a salary of £25,000 a year and pay 3% monthly contributions into your pension from the age of 22.
3 ways pausing pension contributions now could significantly reduce the value of your pension pot later on
It’s not just the value of the missing contributions that you would lose from your pension pot. If you stop contributing to your pension, you could also lose out on the following additional benefits.
1.You’ll have less opportunity to benefit from compound returns
One of the reasons it is so beneficial to start saving for retirement early on is because the longer you leave your pension invested, the more opportunity it has to grow thanks to “compound returns”. This means that you can generate returns on the total value of your pot, rather than simply the value of the deposits you have made into it each year.
Barclays offers a helpful example of how compounding returns work.
Say you invested £10,000 in your pension with a rate of return of 2%. After the first year, you’d earn £200.
In year 2, if your rate of return remained at 2%, you’d generate returns on your total pot of £10,200, adding £204 to your pot.
If the rate of return stayed at 2% over the course of 20 years, the value of your pension pot would rise to £14,859 at a cost to you of just £10,000.
In reality, your rate of return is likely to fluctuate along with other variables, and your pot would also benefit from tax relief on top of your contributions. But this example demonstrates how compound returns could grow your pension over time.
If you were to stop your contributions, that growth could slow, and future returns may be lower as a result.
2. You could be foregoing valuable employer-matched contributions
If you are part of a workplace pension, it’s likely that your employer will match some of your pension contributions. They are usually required to contribute 3% of your salary by law.
These employer-matched contributions are essentially free money from your employer on top of your salary going into your retirement fund. But if you were to pause your own pension contributions, you would lose your employer’s contributions too.
3. You’ll miss out on tax relief
Usually, when you make pension contributions, the government tops up the deposit with tax relief at your marginal rate of Income Tax. Essentially, the Income Tax that you would have paid on the contribution when you received it as salary is put into your pension pot instead.
So, if you’re a basic-rate taxpayer, a £100 deposit into your pension would only “cost” you £80, because 20% of it is made up of tax relief. Higher- and additional-rate taxpayers can receive 40% or 45% tax relief, respectively.
But if you stop making pension contributions for a short period of time, any tax relief you might have received on those contributions will also be lost.
As a result, the money that you saved by not making contributions in the short term could be dwarfed by the amount that could have been deposited in your pension pot.
Get in touch
If you’re thinking of changing your pension contributions, or you’re worried about how rising mortgage costs could affect your retirement plans, we can help. Email us at firstname.lastname@example.org, submit a contact form on our website, or call us on 0333 305 6692.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.