The importance of (not) being idle

As we approach a worsening cost of living crisis with inflation in double digits whilst heading into the costly winter months, making pension contributions understandably may not be at the forefront of everybody’s minds. It is perhaps not a surprise therefore that, according to recent data from financial services firm Scottish Widows, 11% of adults have cut back on their pension contributions or stopped altogether this year. The continued squeeze on real incomes could very well see this trend continuing.

The short-term financial incentive to reduce or stop contributions at times of hardship is naturally high and apparent. The long-term financial incentive to re-start / increase contributions when financial pressures ease, however, is perhaps less apparent, particularly if budgeting without pension contributions becomes a ‘new normal’ for many people. For this reason, there is a concern that lower contribution levels become entrenched which will ultimately limit the lifestyle people can enjoy in retirement.

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So what can we do? In response to the rise in costs many households across the UK have already had to cut back on monthly expenditure. A survey conducted by Scottish Widows indicated that if prices continued to rise, unsurprisingly 34% identified leisure and holidays as the main area that they would cut back further. 

However, some are being forced to make decisions that are concerning. 16% have said the main thing they will cut back on is essentials, while for 8% the main thing they will be cutting back on is non-retirement savings (e.g. rainy day funds). We already know from previous data that 11% have already cut back on retirement savings. 

Clearly, these are challenging times for many households and more people may start to consider the merits of continuing to pay into a pension. At its simplest level, the decision to pay into a pension is centred around the ability and willingness to give up income today in the anticipation of greater future income in retirement.

Naturally, there is no one-size fits all but below are some things to help evaluate both sides of the equation I.e. the actual net cost of pension contributions and the potential long-term impact changes may have on future income.

1. Consider whether you will miss out on valuable employer contributions 

For many people enrolled into a workplace scheme, reducing their personal contributions will reduce (or stop altogether) their employer contributions. For example, an individual automatically enrolled into a pension at the minimum levels will pay 5% of their qualifying earnings with their employer paying in 3%. If we take an example of an individual with £30,000 qualifying earnings:

• They will pay £1,500 gross (5%) into a pension…but this will only cost, as a basic rate tax payer, £1,200 net. 
• Their employer will pay in £900 (3%).

£2,400 is therefore placed into a pension for them at a net cost to the individual of only £1,200.

The minimum overall contribution into an auto-enrolment scheme is currently set at 8%. If an individual reduces their contributions below the 5% then, under current legislation, it would be at the discretion of their employer whether they continue making contributions and make up the shortfall. It is therefore worthwhile  to ensure you are familiar with your workplace scheme to understand the true cost (in terms of lost employer contributions) that any changes you make will have. 

2. The ability to reduce your tax burden

In his Autumn Statement, UK Chancellor Jeremy Hunt announced that income tax thresholds for both basic and higher rate taxpayers will remain as they are until 2027/28, with additional rate taxpayers paying 45% tax on earnings over £125,140 from April 2023. As wages increase under record inflationary pressures, more people than ever before will be pulled into the tax system for the first time, and more people pulled into higher and additional rate thresholds. We have seen this play out already with figures from HMRC showing the number of people expected to pay higher and/or additional rate tax this tax year (2022/23) set to rise to 6.1m, an increase from 4.25m in 2019. 

The good news is that the government has not removed the ability to reclaim higher and/or additional rate relief, which means that for many people the incentive to pay into a pension from a tax perspective has never been greater. 

To provide some context, someone earning £60,000 and paying 5% into their pension would see £3,000 added to their pension per year – but the employee will only see a deduction of £2,400 per annum from their pay, as £600 basic rate relief will be claimed by the pension administrator and added to the pension pot. In addition, as a higher rate taxpayer, a further £600 can be claimed as higher rate relief. A £3,000 contribution has therefore only costed £1,800! 

3. Remember to reclaim higher/additional rate relief

This common mistake will undoubtedly become more common as the numbers pulled into the higher rate bracket rises.  

The majority of personal pension contributions are made through what is called ‘relief at source’, whereby payments are made from net earnings, and the pension administrator claims basic rate relief direct from HMRC and adds this to the pension pot. 

What people often forget is that higher rate relief needs to be actively claimed by the individual, either by completing a self-assessment or by contacting HMRC directly.  Relief will either be supplied as a rebate at the end of the year, a reduction in your tax liability or a change to your tax code.

Failing to reclaim higher rate relief, could be causing households to miss out on thousands of pounds a year. 

4. Consider the long-term impact changes will have

If you stop contributions without a plan, you could be hit with a nasty surprise when it’s too late to do anything about it. The good news is that for those who have no choice but to pull back on contributions in the short term, the damage caused to their pension pot may not impact their future too heavily. But stop for too long and the impact to the value of the pension pot alone could be stark.

What is the key to planning your retirement?

To help find the balance between sacrificing income today for greater future income in retirement, we take clients through an exercise called cash flow modelling. By analysing the assets you already own, the income you might earn and your planned expenditure in the future, we can help establish the level at which you should contribute to your pension, for how long, and the level of return you need your pensions to achieve.

If you’d like to learn more about how we can help you with your retirement planning, please get in touch for a free initial consultation.

If you feel you might value from speaking to us about your retirement plan, get in touch and speak to an adviser.

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Please Note: The value of investments can fall as well as rise.  You may not get back what you invest. The Financial Conduct Authority (FCA) do not regulate cash flow planning.

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up 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. You should seek advice to understand your options at retirement.