Think twice about stopping your pension contributions to save cash
There’s nothing wrong with building up a savings buffer, but don’t let it compromise your long-term financial health
In the second quarter of this year, the UK savings ratio surged to 29.1% – the highest level on record. In other words, for every £100 of income earned, households put away £29.10.1
They also slashed their spending by £80.5 billion in the same April to June timeframe.2
In the midst of an ongoing pandemic, with job security at risk and further lockdowns in the offing, the fact that people are adopting a cautious mindset with their money should come as no surprise.
It’s a pattern that’s likely to continue for some time, as individuals and families prioritise paying down debt and building reserves to get on a more stable financial footing – and ready for whatever’s around the corner.
What’s more surprising is that, while some savings have been realised by, say, abandoning plans for summer holidays abroad, others have come from cutting pension contributions.
Of course, at the best of times, it’s in our nature to think short-term – to feel the most urgency for ‘right now’. And periods of crisis and volatility only serve to amplify this tendency.
As the recession beds in, fuelling our fears, we can’t help but ‘pull up the drawbridge’. But the reality is, indulging these instincts and making knee-jerk decisions could simply be storing up trouble for the future.
Why gamble with long-term security?
There’s no question that it’s prudent – essential even – to have an emergency fund, accessible at short notice, covering at least three to six months’ expenses. But once you’ve got this sorted, it’s wise to shift your focus to the longer-term.
Holding too much cash because you’re feeling uneasy about what the immediate future holds is a recipe for opportunity cost. That’s because the interest you can earn on that cash is – certainly at the moment – next to non-existent.
Indeed, as the cost of living rises, it’ll actually be worth less down the line than it is today – in terms of real spending power.
For example, if you saved £100 a month in an average easy-access cash savings account (currently earning just 0.22%)3, it would be worth £35,910 in 30 years’ time, after inflation.4
If you invested the same amount into a pension returning 5% a year, however, in 30 years you’d have a pot worth £72,416 (calculation includes an annual charge of 0.5% and an annual inflation rate of 0.2%).*5
Long-term pension savings are the smart option – even if it is a little nerve-wracking putting hard-earned money into a pension pot, where it’ll be locked away until you’re 55 (57 from 2028).
If you’re worried that, given the tough situation many businesses now find themselves in, the companies you’ve invested in through your pension – and even your pension scheme provider – may not be around in a few years and could compromise your investments, you can rest easy.
The government’s Pension Protection Fund safeguards the money held in Defined Benefit schemes, and the Financial Services Compensation Scheme protects your Defined Contribution pension if your pension provider fails.
There’s another reason to make the most of your pension contributions in the short-term.
Having already paid out billions to help the country through coronavirus, and with no end to the pandemic in sight, the Chancellor will soon begin to explore ways the government can recoup some of that cost.
One possible option is to introduce sweeping tax reforms that take aim at the likes of pension benefits and tax breaks.
So, there’s an argument for taking advantage of the reliefs and allowances you have at your disposal right now, and investing as much as you comfortably can, before the inevitable ‘tinkering’ starts.
Cut, don’t cancel
If targeting your pension contributions is the only option you have to build your cash buffer, then at least consider reducing your pension payments to the minimum you can, so that you can still benefit from employer contributions.
If you’re self-employed and work has dried up, perhaps you could pause your pension contributions and carry over any unused allowance to the next financial year, when your work situation may look a little brighter.
COVID-19 has forced many of us to refocus on our financial wellbeing, re-prioritise goals, and renew our approach to achieving them. The latter includes recognising that there is expert support on hand to help you make more informed financial decisions.
The time and effort you spend now on planning could pay off massively in the years to come – not just in terms of potential financial reward, but also in the peace of mind that comes with knowing you’re on track for a more comfortable retirement.
Want to understand more about why cutting pension contributions now could cause long-term complications? Looking to create a balanced, financial life plan that works for you? Your St. James’s Place Partner is here to help. Just ask.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested. An investment in equities does not provide the security of capital associated with a deposit account with a bank or building society.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
*This figure is for example purposes only and not guaranteed. What you will get back depends on how your investment grows and on the tax treatment of the investment. You could get back more or less than this.
1Office for National Statistics, Households’ Saving Ratio, September 2020
2Office for National Statistics data, second quarter, 2020
3Moneyfacts, Savers urged to act quickly to secure best fixed-rate account deals, September 2020
4Candid Money, ‘How Much?’ Savings Calculator
5Candid Money, ‘How Much?’ Investment Calculator.