What do your pension contributions mean for you?

September 2022
Gardener
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In the Back to the Future films, Marty McFly, played by Michael J. Fox, is able to travel through time and see how future events can be affected by what happens in the present day. 

Clearly, without access to a DeLorean time machine, you need an element of guesswork and future projection to be able to predict the future with any confidence.

But from a retirement planning perspective, it’s possible to make three statements related to your pension contributions that have an excellent chance of being accurate further down the road:

  1. Regular pension contributions are one of the best investments you can make towards your own financial future 
  2. Stopping your contributions can have a serious impact on your future quality of life when you stop work
  3. The amount you pay in now can make the difference between a comfortable retirement and one where you’re having to count every penny. 

Read on to find out more. 

Your pension may need to fund a substantial proportion of your life
According to  the Office for National Statistics, the average life expectancy for a man aged 50 is 84, and 87 for a woman of the same age. 

That means that if you’re planning to retire at age 65, you could easily have over 20% of your life still ahead of you once you stop working. 

Furthermore, there is a 25% chance of a man currently aged 50 living to age 93. For a woman, that age rises to 95.

With life expectancy figures like these, your pension fund clearly has an important role to play. Subject to any other assets, it’s likely that your pension will provide the bulk of the money you’ll be living on once you no longer have a regular salary. 

This means that maximising your contributions while you have the means to becomes increasingly important. 

3 key reasons why you shouldn’t stop contributing
The current cost of living crisis, driven by rising inflation and relatively low wage growth, is creating cost challenges for many people. 

It’s possible that you may be finding it difficult to balance your household budget, and that you have less disposable income each month. 

An inevitable and understandable reaction is to look to make reductions in your regular outgoings, and you may have considered reducing your pension contributions – or even stopping them totally. 

Here are three reasons why paying your future self should be one of your top financial priorities and, if at all possible, resist ceasing contributions to your pension.

1. You’ll miss out on free money from your employer
Although money usually has to be earned, there are times when it’s effectively given to you free of charge. At times like that, you should really make the most of it! 

One such example is if you’re a member of a workplace pension scheme. By law, your employer should pay a minimum of 3% of your earnings into the scheme. On top of that, you’ll then pay in a minimum of 5% of your income (including tax relief).

You may well be tempted to opt-out from the scheme to save that 5%. However, by doing that you’ll lose those valuable employer contributions, which are effectively extra salary. 

A recent report in PensionsAge looked at research carried out by Aegon. This showed that a pension contribution break of one year for a 25-year-old on average earnings would mean them missing out on minimum contributions of £683 from their employer.

That may not sound like a lot of money, but it soon starts to look more substantial once it’s subject to something that Albert Einstein is alleged to have described as the “eighth wonder of the world” – compounding. 

2. You’ll miss out on compound growth
Whether or not Einstein actually said that compounding was the eighth wonder is open to debate. However, there’s no doubt that compounding interest is a big advantage when it comes to saving for your retirement. 

Compounding is effectively “growth on growth”. So, in the example given above, the value of the lost employer contribution at age 25, could have been increased by 550% to £3,767 by age 60, assuming a gross annual return of 5%.

On top of that you’d also miss out on the compounding effect on your own contributions.

Stopping contributions may save you money in the short term, but the long-term effect on your final fund could be considerable.
 
3. You’ll lose out on free money from the government
As well as missing out on free money from your employer, stopping contributions results in you also missing out on free money from the government. 
When you save into a pension, either through your workplace scheme or into a private plan, the government boosts your pension contributions through tax relief. 

If you are a basic-rate taxpayer and make a contribution of £80 into your pension, it is automatically topped-up to £100. So that’s a 25% uplift on day one – without you having to do a thing. 

Additionally, if you’re a higher- or additional-rate taxpayer, you can claim higher rates of tax relief on your contributions through your self-assessment tax return.

Pensions should be a key part of your long-term financial planning

When it comes to your pension contributions, it’s important to see them as a long-term commitment designed to bring you financial security in your retirement years. 

Clearly, the cost of living crisis means that many people are facing tough financial decisions. But, as you’ve read here, the long-term consequences of stopping your contributions could be costly.

As we are living longer than ever you need to ensure that the money you have now lasts through your entire retirement. This means it’s much more beneficial to look to make some simple budgeting tweaks, so you can stay on track for the retirement you deserve. 

Get in touch
To find out more about how we can help you with all aspects of your retirement planning, please get in touch. Email clientenquiries@lebc-group.com or call us on 0800 055 6585.


Please note:
The information contained in this article is based on the opinion of LEBC Group Ltd and does not constitute financial advice or a recommendation to any investment or retirement strategy. 
You should seek independent financial advice before embarking on any course of action. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
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.

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