Dangers of reducing pension contributions

Have you been tempted to reduce or pause your pension contributions during Coronavirus to improve your finances?

Such a move could provide a short-term cash boost, but Aegon has highlighted the long-term impact on retirement income – which could possibly run into tens of thousands of pounds.

The financial services company says Covid-19 has placed significant financial pressures on many workers, and some may consider opting out of a company pension scheme or stopping contributions entirely for a period.

Others may instead consider reducing pension contribution levels. Aegon has now given examples of what these steps could cost in the long run. A 25-year-old employee on average earnings, paying 6% in personal contributions and receiving 4% from their employer, making a total pension contribution of 10%, might decide to stop contributions to their pension entirely.

If they then started up again after three years at the previous contribution level, this could mean losing out on £15,500 at state pension age.

Steven Cameron, pensions director at Aegon, said:

"For many, the Coronavirus pandemic has placed an extreme strain on finances and individuals may look to areas that can ease the pressure.

"However, those looking to cut back on their pension savings levels should carefully consider the long-term effects on their retirement pot before making any decisions.

"While there may be an immediate boost to take-home pay, Aegon analysis shows an employee in their mid-20s on average earnings could lose out on around £18,400 at state pension age if they decrease their contributions by just 1%, or a 9% fall in retirement income. But the saving in take-home pay would only amount to £14 after tax relief.

“The shortfall could be even greater if they are in a scheme where their employer 'matches' their contributions. If their employer also reduces their contributions by 1%, the shortfall would double to £36,800.

"The power of compound investment growth means it's the pension contributions paid in the early years that have longest to grow and make the biggest difference in ultimate retirement income. But, for those closer to retirement, a small reduction in contributions can still have a big impact.

"Some employees might consider 'opting out' of their pension scheme for a period to ease financial pressures. However, it is important to understand the implications of this as they will not only miss out on personal contributions, but also lose valuable employer contributions which help to boost retirement savings."