PENSION PAUSING IS A LAST RESORT
TRICIA PHILLIPS says think twice when trying to save money now by risking your financial future
AS a nation we are in a crisis, particularly with our personal finances. And with inflation hitting double digits, we are all feeling the effects in our weekly shopping.
In all this economic gloom, it is easy to look short-term at our own finances and work out what we can do without or cut back on.
And many people are thinking about their pension savings – something way off into the distance – as one possible way to cut back.
One in 20 adults have said they have already stopped their contributions into their company pension scheme, according to recent research from financial giant Canada Life.
A further one in 20 savers say they are actively thinking about pension pausing, while one in 10 might consider doing so in the future.
Latest figures from the Department for Work and Pensions show the cost-of-living crisis is having an impact on pension savings with the proportion of savers opting out of workplace pensions rising from 7.6% in January 2020 to 10.4% in August this year. As the financial turmoil continues these numbers are set to rise further.
But what could this mean for your long-term financial health?
Andrew Tully, technical director at Canada Life says: “The cost-ofliving crisis is putting an incredible amount of strain on people’s finances. With the financial situation deteriorating, the squeeze on the nation’s finances is only set to get worse.
“It’s understandable that people who are really feeling the pinch are considering opting out of their company pension. Affording food and heating in the present day will always take priority over saving for the future.”
What is the true cost of opting out?
Opting out of a company pension for just one year could reduce the value of your final pot by 4%, all other things being equal, according to the number crunchers at Canada Life.
This is based on someone earning £50,000 a year at age 40 and paying a combined contribution of 8% (5% from the employee and 3% from the company) and pausing for a year.
They would have built a pension worth £386,999 at age 67, but missing a year of contributions would mean a pension worth £371,318, or 4% less.
If they stopped for three years, instead of just one, they would have 12% less in their final pot – £340,404.
If they stopped for three years, to claw back the deficit they would have to pay in just over 9% ongoing rather than the original 8%.
In the case of someone earning £30,000, saving 8% of salary from age 30, they would have built up a pension worth £490,559 at age 67, or by skipping one years contributions, a pension worth £475,234, just over 3% less.
Skipping three years’ contributions would shrink their final pot to £445,020, just over 9% less. To make that good after the three years they would have to pay in 9% ongoing, rather than the 8%.
What other options may you have?
Firstly, think seriously before opting out of your pension. Do you have any other savings you can use right now to tide you over? Could you perhaps reduce your level of contribution, rather than opt out altogether?
This would mean you’d still receive the benefit of tax relief on your remaining contributions, and would also reduce the impact of reduced contributions in the future. It would also mean you still gain the benefit of at least some employer contribution.
However, 8% is the minimum you can pay an employer scheme under the auto enrolment rules – 5% from the employee and 3% from the employer. So, you could only reduce the amount you contribute if you are paying above these levels.
What should you do if you do need to stop/reduce contributions?
Have a clear plan or path to recovery, ideally as soon as you are back on your feet financially. Don’t leave it or ignore it, as pension saving should be a long-term goal.
The more time you are out of the savings habit the bigger impact it will have on your pension pot.
Andrew Tully explains: “It’s really important that anyone who does decide to opt out of their pension remembers that they can choose to re-join the scheme as their financial situation improves.
“It’s worth remembering that if you are in a company pension scheme you can often only choose to stop or start contributions once a year, and you will miss out on valuable top-ups from your employer and the Government.”
If you choose to opt out of your company pension scheme, your employer is under no obligation to pay their employer contribution to you as extra salary. You’ll miss the tax perks and ‘free’ employer contribution which is incredibly valuable.
Also, if you opt out you won’t receive a refund of contributions previously made to the pension scheme, they’ll be invested on your behalf until you retire, or reach the age of 55, soon to be 57 – the earliest age you can access pension savings.
Your employer will contact you every three years and automatically opt you back into the pension, unless you’ve contacted them before that, although they may do it sooner.
Employers typically have an annual window where pension scheme members can make changes, such as opting in or out, or changing their contribution levels.
You could also set up an ISA to put some longer-term savings into as and when you can afford to put a bit away, once your finances are in better shape. That would give you an extra pot of cash for your retirement – and it comes with no tax issues in the future.
Are pensions still safe given the turmoil in financial markets?
The short answer is yes. The Bank of England has had to intervene to shore up markets in an emergency move following the disastrous minithrough
Budget to create some economic stability. The issues with the market relate to the funding of defined benefit, or final salary pension schemes.
The key is the strength of the employer to make good on the pension promises of the scheme. If the employer continues to operate there is no real issue.
For people auto enrolled into a pension, you’ll hopefully be investing in well-diversified investments spread across various geographical locations as well as asset classes, so your exposure to the UK economy and recent turmoil will be limited. And even then, you should have time to make good any paper losses unless you plan to access your pension soon.
For those building up savings there is even a benefit to paying money in when markets are lower, as you are buying investments at a lower price which may grow more in future.
Andrew Tully concludes: “Many people will face the choice between heating and eating this winter. Piling on the pressure to continue paying into a pension while trying to make ends meet will be a tall order.
“If you do need to pause saving, have a plan to re-join the scheme when you are back on your feet, so you regain the benefit of your employer paying into your pension.”
If you do need to pause saving, have a plan to re-join the scheme Andrew Tully of Canada Life