If you run a business, it’s likely that you’ve endured a tough few months. While City AM report that the UK may avoid a recession in 2023, you’re likely to have faced a few headwinds such as reduced consumer spending, and the increased costs of raw materials and energy.
According to Federation of Small Business figures reported by the Guardian, businesses experienced a 424% rise in gas costs and a 349% increase in electricity between February 2021 and August 2022.
To keep costs under control, you may have spent the last few months looking for ways you can reduce expenses. One of the options you may have considered is to pause your pension contributions.
Indeed, Professional Pensions reports that 1 in 5 defined contribution (DC) schemes have seen an increase in requests from members to cut their pension contributions over the last three months.
While it might seem like an easy way to trim your expenses now, pausing your pension contributions could have significant long-term consequences. Read on to learn more.
You’ll lose valuable tax relief
When you save into a pension, the government boosts your pension contributions through tax relief. This is true if you’re employed or self-employed. Essentially, the money you would have paid in tax on your earnings goes towards your retirement savings instead.
The amount of tax relief depends on the rate of Income Tax you pay. If you are a basic-rate taxpayer and were to contribute £100 from your salary into your pension, it would actually only “cost” you £80. The government adds an extra £20 on top – equivalent to what it would have taken in tax from £100 of your salary.
If you’re a higher- or additional-rate taxpayer, a £100 contribution only “costs” you £60 or £55, respectively. You can claim this additional tax relief through your self-assessment tax return.
If you own a limited company, your business could be making contributions to your pension scheme. These contributions may well be treated as a business expense and offset against your business profits, which could help reduce your exposure to Corporation Tax.
Additionally, using this method means that your business will not have to pay National Insurance contributions (NICs) on the money placed into a pension.
If you pause or reduce your pension contributions, you’ll lose all this valuable tax relief. So, in addition to pausing your own contributions, you’re also pausing this “free money” that is going into your pot to fund your retirement.
Over years, this can have a significant effect on the eventual value of your fund.
A short-term pause can have a big long-term effect on your pension fund
When you pause your pension contributions, you don’t just lose the value of your contributions and the tax relief. You also lose the potential growth on those returns.
Compound growth is essentially “growth on growth”. Think of it this way: If you invest £1,000 and get a 5% annual return, in a year you’ll have £1,050. If you get a 5% return in year two, you’ll have £1,102.50. In year three, you’ll have £1,157.62.
So, while pausing or reducing your pension contributions now could save you some money, you’ll lose the potential returns from the money you’re no longer investing.
HL share an example that shows how pausing even a small contribution now could leave you thousands short in the future.
If you pay £100 into your pension today, and you’re a basic-rate taxpayer, it’ll be worth £125 after tax relief is added.
Assuming it grows by 5% above inflation after charges, it could be worth about £540 in 30 years.
So, pausing your pension payments of £100 each month for a year could mean you miss out on more than £6,000 in your pension after 30 years, assuming 5% growth after charges. That could mean you’d have to work a few more years to make up the difference.
Stopping higher contributions, or pausing for a longer period, would have a greater impact on your fund.
Pausing now may mean you don’t have “enough” later on
One of the rewards of a lifetime of hard work is that you get to enjoy the retirement you want later on. So, pension contributions now are essentially “paying your future self” as these are the funds you’ll be living on when you decide to stop working.
As you read above, pausing your pension contributions means losing money in your pension pot, tax relief, and the potential returns on those savings. This can total a significant sum when considered over the years to your retirement.
The consequence is that:
- You may not have enough to retire on your terms
- You may have to make sacrifices in terms of retirement spending if you don’t have the resources you need.
Both of these outcomes are sub-optimal, so prioritising your pension savings now can ensure you can live the life you want in the future.
Get in touch
If you run your own business and you’d like to take control of your finances or explore ways of ensuring you reach your retirement goals, we can help.
Email hello@sovereign-ifa.co.uk or call us on 01454 416653.
Please note
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
