The dangers of pausing your pension contributions

Finding ways to cut back on your spending may help you ensure you can still meet your financial obligations and work towards long-term goals. However, it is important to think carefully about where you make those savings.

A recent survey from Royal London revealed that 33% of workers have considered pausing their pension contributions. While this may increase your monthly income, it could have disastrous long-term consequences.

You may have to make sacrifices to your lifestyle in retirement

When you create a retirement plan, you typically build a picture of your ideal lifestyle in retirement and determine how much it is likely to cost. You can then set a savings goal and calculate your contributions, so you can ensure you are able to fund your desired lifestyle when you retire.

Yet, if you pause your pension contributions, even for a short while, you may find it far more difficult to reach that savings goal.

According to the report from Royal London, a 40-year-old earning £35,000 a year and making a 5% pension contribution could increase their annual income by £1,404 if they paused their contributions.

And stopping pension contributions doesn’t only mean missing out on their own payments. The person in the previous example would also lose valuable tax relief and employer contributions meaning they would skip £4,092 in pension contributions every year.

This could lead to a shortfall in your retirement savings and ultimately, having to make sacrifices to your lifestyle.

You could miss out on valuable compound growth

Your pension provider invests your savings, potentially generating valuable growth over time. Compound interest means that you generate growth on the total value of your pension pot, rather than just the value of the contributions you make each year.

For example, if you invest £1,000 in a pension with 5% growth, you will earn £50 after the first year. The following year, you generate 5% growth on the total of £1,050, meaning you generate £52.50.

The compound effect means that your returns could increase each year and create a positive snowball effect. Over an extended period of time, with regular contributions, this could give your pension savings a valuable boost.

That’s why it may be beneficial to leave your pension savings invested for as long as possible. Yet, if you pause your contributions, you slow this compounding effect, and this could considerably reduce the size of your pension pot.

Your pension could be less likely to keep pace with inflation

You may be considering pausing your pension contributions due to high inflation. Although having more money in your pocket each month could make it easier to manage rising living costs, it’s important to remember that inflation isn’t going to disappear as many consider it a necessary feature of the economy.

The Bank of England (BoE) aims to keep inflation around 2%. This means that costs are likely to continue rising in the future, albeit not quite so sharply as we have experienced more recently. Additionally, we could experience another period of high inflation in years to come.

Provided your pension is growing at the same rate or faster than inflation, your savings will still have adequate spending power when you come to retire.

Conversely, if you pause your contributions and you do not benefit from compound growth, your savings may struggle to keep pace with inflation. In practice, this means that the real-terms value of your pension pot could shrink over time.

Pausing contributions now might mean paying more later

If you pause your contributions, you may find that you fall short of your retirement savings goals. As you approach retirement age, you have several choices.

You could make sacrifices to your lifestyle, so you are able to afford retirement with your reduced savings. Alternatively, you could delay your retirement and continue working for longer to meet your original savings goal.

However, both options involve compromising your retirement plans, which you may not want to do. This may mean that you end up having to increase your pension contributions later in life to make up for the shortfall.

As a result, you could have less money in your pocket each month and you may have to deal with the same budgeting challenges that you were attempting to avoid by pausing your contributions.

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Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

Posted in News, Newswire.