In the face of a recession, more of us are curbing our spending and neglecting our pension pots. Here's why you shouldn't make the sacrifice.
Rises in the cost of living over the past year have caused many of us to re-think our spending priorities and in some cases consider cutting back on our pension contributions.
In fact, according to new research from insurance and pensions group AXA, some 1.5 million pension holders are planning to stop their pension contributions in a bid to stave off the effects of the impending recession.
AXA has calculated that if all those with plans to take a pension break stopped contributing for two years, as much as £34.97 billion could be lost from 1.5 million pension funds*.
According to the figures, one in twelve pension holders feel they will be left with little choice but to take a pension holiday in the next two years, with 35-44 year olds most likely to cut saving. Of those planning to take a pension break, 53% said they were doing so to help offset the increased cost of living or to clear debts, with a further 13% citing increased mortgage payments.
The repercussions
Taking a pension holiday can be very tempting, particularly when you have more pressing payments to make like your mortgage and your food bills. But ultimately, neglecting your pension pot will make you a lot worse off when you come to retire.
The table below illustrates how a two year pension break** could affect you, depending on your age.
Age | Occupational pension contributing 9.5% of UK average salary per month | Individual stakeholder pension contributing £300 per month |
|---|---|---|
Amount lost from total pension fund at retirement | Amount lost from total pension fund at retirement | |
28 | £33,800 | £59,700 |
35 | £28,700 | £39,800 |
45 | £16,900 | £22,400 |
55 | £8,500 | £12,500 |
Source: AXA
Even though a two year pension break might not seem like a long time in the grand scheme of things, the chart illustrates that you will still be losing out on a significant amount of money when you come to retire.
In addition, it highlights how thinking about your pension fund isn't just something you should be doing when you are only a few years away from retirement. In fact, the younger you are, the worse neglecting your pension is.
This is because if you start contributing to your pension pot when you are young, your investments have many more years in which to grow than they would do if you were making contributions close to your retirement. So that means if you took a break from investing in your pension at the age of 28, you would be making a far greater loss than a 55 year old would be.
Cut back elsewhere
Rather than sacrifice your pension pot, it is far better to try and make cut backs elsewhere. Admittedly, in times like this, it can be a struggle, so the best way to help you do this is to keep a spending diary and set up a list of earnings and outgoings - you can do this by using a nifty online calculator known as a statement of affairs.
Make sure you are completely honest when you do this as it will enable you to weigh up exactly what you are spending where, and where you can make some changes. This might include cutting down on socialising, making your lunch instead of buying it out, or cancelling your gym membership. By doing this, you will have saved yourself some cash without neglecting your pension pot.
For more help on budgeting, read Five Steps To Brilliant Budgeting and of course, you can always check out our Money Saving Tips for more ideas.
What about the volatile stock market?
Of course, if you have a share-based pension fund, you may feel now is the ideal time to take a break from your pension payments given the volatile nature of the stock market.
But I would strongly advise against this. In fact, a volatile market can give your investment a helping hand, particularly if your retirement is still a long way off.
By drip-feeding money into your plan, you can benefit from what is known as `pound cost averaging'. This allows you to enjoy upturns in the market while cushioning your investment from any downturn.
If, for example, you contribute £100 every month to a personal pension scheme, each contribution will buy shares - or units if you are investing in a unit trust - at a range of different prices as the market fluctuates. This means that when the market is climbing, you will buy fewer shares with your £100, but in a falling market you will simply acquire more shares with the same £100.
By investing regularly over any period, the average price you'll pay for your shares/units will always be lower than the average market price, no matter whether you're investing in a rising or falling market. For more on this topic, you can read my Foolish friend Jane Baker's article.
So rather than focusing on the deteriorating value of your pension plan in a falling market, see it as an opportunity instead. You can buy more shares for your money and when the market recovers, the shares you bought at a lower price will be poised to gain in value. (This will also depend on how close you are to retirement.)
Even if it seems a struggle, avoid cutting your pension contributions if you can. Although it may be difficult to see the value of it now, it really is a valuable investment for your future.
*AXA actuaries conducted a comprehensive analysis of individual and occupational pension contributions, calculating fund values and annuity values that will be forgone if a 2 year pension break is taken at age 35, 45, or 55, or if a person aged 28 delays their pension by 2 years.
**Assumes break using national average salary and assuming 9.5% contribution rate at 1% annual management charge.
More: Falling Interest Rates Are Bad For Your Pension | Protect Your Retirement Savings From Recession