Pension contributions are often the first cuts made when money is tight. It’s understandable – the benefits of these savings are not realised for many years ahead, so it’s easy to pause contributions.
But many do this with a huge misconception that you can make up for it at a later stage, and it is not as simple as that. The moment you stop, you miss out on compounding, free money from your employer, and the tax rebates – you cannot make up a pound for a pound at a later stage.
So while stopping pension contributions may seem like the obvious way to boost your immediate income, it could cost you thousands in later life.
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What are the costs of stopping pension contributions?
Research from investment platform Moneybox shows the average earner (£39,000) could boost their annual income by £1,000 by pausing pension contributions for one year, but the cost of doing this is £12,000 on their overall retirement pot.
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The longer you stop, the more significant the impact is. Standard Life finds a 22 year old on £25,000 paying the minimum contribution of 5% and getting 3% from their employer could build a pot of £210,000 by 68. But if they pause contributions for two years between 30 to 32, the pot would only be £200,000. A five year pause between 30 to 35 would mean you take a financial hit of £25,000. And should you take a long break of 10 years between 30 to 40, you could end up with £49,000 less.
There may be many reasons that force you to stop paying into your pension, such as taking a break to raise a family, redundancy or going self-employed. Often, just wanting more money in your pocket each month is the reason. Life happens, but is pausing pension contributions always the only solution?
What can I do instead of pausing pension contributions?
If you are looking to boost your monthly income, then instead of pausing pension contributions, take a look at other ways you can cut your costs.
For example, as simple as it may sound, having a budget in place can help identify unnecessary spending and costs. For example, are you paying for unwanted subscriptions? This is one trap I find myself often falling into.
Ask yourself if you could also get cheaper deals on broadband, mobile phones, or insurance costs. I recently saved £400 on my home insurance by simply switching to a new provider instead of accepting the renewal quote.
You may find that you can save a lot more with a budget and slashing unnecessary costs than you would by temporarily pausing pension payments.
If you have little choice, then think about gradually paying in more when you do restart pension contributions. You could even pay in bonuses or pay increases to give your pension pot an ad hoc boost. And if you're lucky to have an employer who is happy to match increased contributions, then this is worth considering as this is free cash from your workplace that you may otherwise not get.
How much do I need in my pension?
If you think losing a few thousand off your pension pot may not be a big deal, then it is first worth thinking about whether you will have enough in the first place.
Most people underestimate the income they would need in retirement and how big the pension pot needs to be to deliver that. Two-thirds of your pension will typically come from investment growth, so the longer you are invested the better.
According to Pensions UK, a single person would need to have a post-tax income of £45,400 for a comfortable retirement – or £62,700 as a couple.
The single person would need a pension pot of £691,000, according to analysis from wealth management company Quilter, while a couple would need a combined pot of £778,000.
The’ rule of 300’ for retirement
Another way to work what you need to maintain a certain lifestyle when you stop working is by using ‘the rule of 300’ by Standard Life. You simply multiply your everyday costs by 300 to estimate what it will cost you throughout retirement.
So, for example, if you pay £12 subscription a month, multiply it by 300, meaning you would need £3,600 in retirement to continue to pay for it. And if your golf membership is £75 a month, you will need £15,000 to carry on golfing.
So, before you stop pension payments, it may be worth thinking about the retirement you really want and how you will pay for it.
