With the current cost of living crisis, it can be easy for savers to view ceasing their pension contributions as a way to save money in the short term, particularly if they are a long way off retirement. This article looks at why it is so important to continue to save for retirement where possible and also the benefits of starting to save as early as possible.
More time to grow
We will start with an obvious one. The longer you save into a pension, the more time your money could benefit from potential investment growth.
Taking advantage of a long term investment strategy
Many workplace pension default investment strategies make use of a lifestyling option. Lifestyling is an investment strategy which provides automatic switching of your savings into lower risk funds as you get closer to retirement. The strategy typically invests more aggressively when savers have a longer term to retirement, taking advantage of the growth potential at a point where the saver will not be impacted by short term volatility in the stock market – as they are not accessing their funds at this point. The more savers invest early, the longer they will be able to benefit from the growth potential of such a strategy.
Pound cost averaging
Pound cost averaging refers to investing smaller amounts of money regularly rather than making larger one off investments. The benefit to this is that you will be buying units in your pension regularly – due to market volatility, there will be times when you are investing at a high point in the market (therefore buying fewer units) and times when you are investing at a lower point (thus buying more units).
By starting contributions into a pension as soon as possible and continuing to make regular contributions over a long term period, savers can benefit from capturing the average of the market thus negating the potential market timing risk when making investments. The alternative option of making lump sum contributions later in life does not carry the same averaging effect and could mean investment is made at a higher point in the market (purchasing fewer units) and therefore more exposed to market timing risk.
Affordability
While the cost-of-living impact on day-to-day expenditure cannot be ignored, it is important to consider the longer term implications of affordability of ceasing contributions into a pension in the short term. We highlighted the benefits of pound cost averaging above, however it is also important to consider that smaller regular contributions are more sustainable in the long-term compared to the strategy of making larger one-off contributions as you get closer to retirement. Larger one-off contributions are likely to have a more significant impact on day-to-day cashflow at that point than smaller regular contributions will have now.
State pension
Saving into a private pension will ensure you have additional retirement savings on top of the state pension.
The current full flat rate state pension income is £185.15 per week which requires you to have a minimum of 35 years of National Insurance Contributions (NIC) or credits. The age that you become eligible for this is currently 66 and will gradually increase to 67 between 2026 and 2028 – it is likely we will see further increases in the future.
In contrast, you can access private pensions from age 55 – increasing to 57 in April 2028. Therefore, if you are looking to retire earlier than the state pension age and hope to have a larger income than that provided by the state, it is important to contribute as much as you can to build up your additional pension provision. As seen from the points outlined above, the earlier you start saving, the better chance you will have of a reasonable sized pension pot.
Tax efficiencies
Individual pension contributions are eligible for tax relief up to certain limits. Obviously this benefits you in terms of your pension provision, however it could also benefit you in your everyday expenditure too. Government benefits such as child benefit and tax-free childcare are assessed on your ‘adjusted net income’. Your ‘adjusted net income’ is reduced by contributions which you make to the pension. This can be beneficial to those who are above the thresholds to receive such benefits – by making contributions to a pension, they may become eligible.
In addition to this, individuals typically see their personal allowance (the amount of income earned not subject to tax) reduced by £1 for every £2 of income above £100,000. By making a pension contribution to reduce their “adjusted net income”, they may be able to reclaim some or all of their entitlement to the personal allowance, which gives an effective tax relief rate of 60%.
Care must be taken when considering how much to pay into the pension and individuals should consider taking advice before making a decision.
Summary
Taking all of the above into consideration, it hopefully highlights that although it can be tempting for savers to see ceasing pension contributions as an easy way to make savings in the short term, it may also be a very costly one in the long term. Making regular contributions over a long term allows savers one of the best chances of having sufficient pension provision in retirement.
