Beware cutting your pension contributions

I AM currently putting in 8% into my pension with my employer putting in 3%. However, with the rising cost of living, I am considering reducing my contribution. How much should I reasonably be putting into my pension and if I cut it, how much by?

Jenny says…

With household budgets under huge pressure, many of us will be trying to make cutbacks wherever we can.

But while saving for the future might not seem a priority at the moment, cutting your pension contributions could store up more financial challenges for a later date.

When you pay money into a pension you benefit from tax relief, which boosts a £100 contribution to £125 for basicrate taxpayers. This money is invested by your pension scheme.

Thanks to tax relief and investment growth, any contributions you make today are likely to be worth much more by the time you retire.

Even reducing contributions by a small amount could have a significant impact on your retirement income.

The insurer Aegon estimates that if a 25-year-old employee on average earnings were to reduce pension contributions by just 1% of earnings until state pension age, it could mean losing out on £18,400.

What’s more, if that 1% reduction were to be matched by the employer, the amount the employee would lose out on at state pension age doubles to £36,800.

Under auto-enrolment rules, the minimum total contribution for a workplace pension scheme is 8% of your ‘qualifying earnings’ – made up of 5% from you (including tax relief ) and 3% from your employer.

Unfortunately, even this isn’t guaranteed to deliver a decent enough income in retirement. As illustrations from AJ Bell show, a 30-year-old earning £30,000 a year could end up with a fund worth around £306,000 at 68 (state pension age) if they contribute 8% of their salary into a pension each year.

This would only give them a drawdown income of around £10,000 a year until their mid90s, after they’ve taken their 25% tax-free lump sum.

This falls short of the £13,000 that Which? research suggests is enough to cover essentials (including food and drink, mortgage or rental payments, transport, utility bills and insurance).

The combined figure for couples is £18,000.

To achieve a ‘comfortable retirement’, which includes the essentials plus regular short-haul holidays, other leisure spending and charity donations, the average income a two-person household would need is £26,000. Single-person households would require closer to £19,000.

If you do decide to reduce your workplace pension contributions you’ll first need to check whether this is an option with your employer and your pension provider.

In cases where this would involve paying less than the minimum, it’s not just the employee’s contributions that

Even reducing contributions by a small amount could have a significant impact.

would go down – but possibly the employer’s too.

In theory, they could stop paying altogether because they’d no longer be bound by autoenrolment rules.

As you’re currently paying more than the minimum, reducing your contributions doesn’t need to involve forfeiting those from your employer, but do ask yourself whether the money you’ll be freeing up is really worth the long-term hit to your pension pot.

You can choose to increase your contributions again at any point – just let your employer know in writing.

To get a better idea of how much your pension pot might be worth at retirement, and how much income this could give you, use Which?’s free pension calculator at which.co.uk/ pensioncalculator.