Taking a break from making pension contributions may seem like a good idea when money is tight. However, Beverly Lavin highlights a very different outcome
Pensions by their very nature are not a standard investment. According to a recent survey1, the average UK citizen begins saving for their retirement when they are 28 years old. At that point, they are diligently putting away money that they won't see again for at least another 27 years. So by any standards, pensions are an investment where any rewards become apparent over the longer term.
Partly because of this view, pension contributions are one of the first things to be cut when personal budgets are squeezed. This is particularly relevant now as we enter what many predict will be a serious economic slowdown.
Already repayments on some types of mortgage have increased by £200 since mid March2 and a report from Moneyexpert.com reveals that 76% of motorists claim that increasing petrol costs are dissuading them from driving. As a result, many people prioritise immediate costs such as paying their mortgage or filling up their car above long-term saving for their retirement which may be decades away.
Taking a break
There are plenty of pointers which indicate that many people are already looking to their pension contributions as a way to reduce monthly household expenditure. Brewin Dolphin recently conducted a survey which found that one in ten pension savers expect to "stop", "pause" or "reduce" their contributions over the next month due to the current economic outlook. Most likely to do this are people in the 25-34 age bracket - or people with pensions who are furthest away from retirement. Even more startling, the average planned length of these "pension payment breaks" is almost two years3.
These figures are borne-out by a recent report from Prudential The insurer believes that voluntary pension contributions have almost halved in the past year, and argues that workers who pay into company and private pension schemes are paying £134 less a month than a year ago.
In other words, people's purse strings are being pulled tight, and the first victims are pension contributions.
However natural it may seem to put your pension on hold, doing so could be costly - especially for people in their twenties and thirties who have decades to wait before they can draw the money.
Because money put into a pension pot by someone a long time away from retirement will have more time to 'grow' through investments by the pension fund (assuming the fund is successful), then a cut in contributions by a younger person can make a larger difference to their eventual pension than a cut by someone older.
The message is that cutting your pension contributions is generally a false economy, and to top your pension pot up to previous levels could prove very difficult.
Counting the costs
Take the example of a 32-year-old man aiming to retire at 58 and saving £400 a month into his pension fund - which is currently valued at £40,500. On retirement in 2034, he could expect a £791,760 pension pot.
However, if he stops paying into his pension for just one year, the pot would be worth just £756,201. This means that a saving of £4,800 today has translated into an eventual loss of £35,559. To make up the difference, he would have to increase his contributions by 20.3% - in other words pay £975 extra every year thereafter (there are a number of assumptions made in this example in order to factor pension growth and other factors - for full details see www.brewin.co.uk/pensioncalculator/assumptions.aspx).
In other words, the effect of pauses are magnified, and will lead to a depletion in eventual pension pots, to a far larger extent than most people would imagine. These are not the only dangers of taking a pension break; by not investing when the market is depressed, the benefits of pound-cost averaging could be missed. Also, in cases where people have SIPPs, by withdrawing from the market they may miss any one-off investing opportunities, such as an illiquid asset suddenly coming on to the market, that are available during the interim.
As a result, Brewin Dolphin would counsel people to push pensions - despite their 'dry' image and despite how distant retirement might seem - slightly up their list of priorities. In practical terms, this could mean that if a client has money invested, it is worth investigating whether their focus should be tilted towards income rather than growth, at least in the short term.
Brewin Dolphin has put together an online tool to roughly calculate the effect that stopping or reducing pensions would have on eventual pots. It can be found at www.brewindolphin.co.uk/pensioncalculator.
1 Source Axa survey
3 32,057 adults were interviewed online by research company TNS. Fieldwork was conducted between 5th and 11th February 2008
Joined as head of strategy, multi asset, in June
Group income protection
Nine in 10 do not have income protection
Set to become part of Single Financial Guidance Body