Suspending your pension contributions? Remember the magic of compounding
Think very carefully before suspending your pension contributions, or you will miss out on compound interest – the “eighth wonder of the world”.
For anyone struggling with the financial impact of the Covid-19 crisis, saving for a retirement potentially still many years off may feel like a low priority. But while it may be tempting to cut back on pension contributions, or to stop saving altogether for a time, the long-term cost of doing so may be much higher than you realise.
The problem is particularly acute for younger savers, with the effect of compound interest multiplying the impact of missing pension contributions. Figures from the pension provider Aegon suggest that a 25-year-old saver who is a member of their workplace pension scheme but suspends contributions for three years could see their final pension fall by 7% as a result.
Aegon’s calculation assumes the saver currently earns the average wage and that suspending their contributions results in their employer doing the same, as would be the case in most workplace schemes. On that basis, the saver could expect to have a pension fund worth £194,100 on retirement at state-pension age, £15,500 less than they could look forward to had they maintained their contributions.
An average saver who suspends pension contributions for three years would see their income boosted by around £4,000 over the whole period. But taking into account lost tax relief, missed contributions from an employer, and investment growth foregone, the impact on their final pension fund would be almost four times as high.
Get back on track quickly
Pension experts also worry that people cutting back on pension contributions today may not get round to increasing their savings for many years, even when their financial position improves. Again, the impact could be dramatic. A 25-year-old saver who reduces their pension contribution by just 1% could lose 9% of retirement income if they never get round to raising their savings once again.
That would rise to 18% for members of workplace pension schemes whose employers match their contributions and therefore cut back on what they pay in. With some official data suggesting that younger people’s finances have been disproportionately affected by the Covid-19 crisis, some advisers now fear a significant long-term pensions problem. But while pension contributions paid early in life have the greatest effect on final pension income, older savers suspending contributions will also face significant impacts.
Inevitably, some people will feel they have no choice but to cut back on retirement saving given the state of their finances in the current environment. But if so, it’s crucial to get back on track as soon as your circumstances allow – and to consider topping up pension contributions, if possible, to begin to reduce the shortfall.