3 reasons why you shouldn’t cut your pension contributions during the cost of living crisis

Category: News

The rising cost of living might have left you struggling financially. As you look to cut costs in the present, you might consider making changes to the amounts you pay your future self, either by decreasing or stopping contributions into your pension.

While this might seem like a good plan now, it could have a big effect on the lifestyle you can live in retirement.

Keep reading for three reasons why you shouldn’t cut your pension payments during the cost of living crisis, and some alternative courses of action.

Cutting your pension payments to increase your monthly budget isn’t a good idea in the long term

In May 2022, the Office for National Statistics (ONS) confirmed that inflation rose by 9% in the 12 months to April, the highest increase in 40 years. Along with a rise in household bills, April also saw an increase in National Insurance contributions (NICs).

The dramatic rise in household fuel bills has led many people to look for ways to reduce their monthly outgoings. This is Money recently reported on the effect of reducing your pension contributions by the amount of the average fuel bill rise.

The price cap increase that came into force in April, will see the average customer paying an extra £57.75 a month. A pension saver in their 20s who takes this extra amount from their current pension contributions could retire £77,000 worse off, according to the report. This figure assumes energy bills remain at the new rate.

Bills might decrease in the future, but it is worth noting that the price cap is due to rise again in October, increasing bills by a further 32%.

3 reasons why you shouldn’t cut your pension payments

1. You will lose valuable tax relief

When you contribute to your pension, you effectively receive a government “top-up” in the form of tax relief.

It is paid automatically at the basic rate of 20%. This means that a £100 increase in your pension only costs you £80, with £20 added by the government. As a higher- or additional-rate taxpayer, you can receive extra relief up to 40% or 45% respectively.

Tax relief above the basic rate is applied automatically and must be claimed using your self-assessment tax return.

If you reduce or stop your pension contributions, you will miss out on some or all of the tax relief available to you.

2. You will miss out on employer contributions

Under current auto-enrolment rules, the minimum contribution is 8%. This comprises 5% from you and 3% from your employer.

If you opt out of auto-enrolment, you’ll “save” your 5% contribution but miss out on a 3% employer contribution, effectively saying goodbye to “free” money.

Dropping from an 8% pension contribution each month to nothing could make a huge difference at retirement.

3. You could see lower investment returns and a diminished impact from compounding

If you reduce or stop your contributions, you’ll be lowering the potential size of your pension pot at retirement.

While your invested amount can fall as well as rise, a carefully risk-managed pension investment will be aligned to your retirement goals. Any change you make now could alter your plans. This might mean that you need to:

  • Contribute more, later in your career
  • Keep working for longer than you originally planned
  • Rethink the kind of lifestyle you live when you retire.

You’ll also lessen the potential effects of compounding.

Compounding means receiving interest, or growth, on the interest you make. Because a pension is a long-term investment, the effects of compounding over time can be huge.

Revisit your retirement plans now and you might be able to avoid cutting contributions 

Calculate how much money you’ll need when you retire

If you’re considering reducing or stopping your pension contributions, revisit your plans and work out how much money you’ll need to retire on your chosen date.

A recent Which? survey revealed that a couple would need at least £26,000 a year to live a “comfortable” retirement, including a European holiday each year and a dining-out budget. For a single-person household, this figure is £19,000.

Discuss your pension with your employer

Before deciding to stop your pension contributions, talk over your options with your employer.

You might discuss reducing your payments rather than stopping them and find out if they offer a salary sacrifice scheme. The latter could save you and your employer money in NICs but needs careful consideration.

Opting for salary sacrifice effectively lowers your salary, which could affect your entitlement to some benefits and make securing a mortgage harder.

Speak to us

Securing a comfortable retirement is a crucial part of your long-term financial plan so be sure to speak to us before you make any decisions.

We can use cashflow modelling to help you understand how much you’ll need to live the lifestyle you want. We can help you decide if you are saving enough, assess the potential effect of any future changes, and help you budget in the present while still providing for your future.

Get in touch

If you are worried about the cost of living crisis and what it might mean for your retirement, get in touch now.

Email info@lloydosullivan.co.uk or call 020 8941 9779 to see how we can help you.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Workplace pensions are regulated by The Pension Regulator.