What a fall in income means for your retirement plans

Martin Ansell, pension expert at financial advisers NFU Mutual said: “These figures highlight the long-term hidden impact the pandemic will have on retirement plans. Although the furlough scheme has kept many people in employment, reduced salaries lead to reduced pension contributions.

“Many will have missed out on generous tax reliefs during this period, and may have to contribute more to their pension in the future to have their desired retirement.”

Understand the implications
Some people will have no option but to reduce the amount they pay into their pensions so that they can focus on more immediate financial priorities. However, it’s vital to try to resume contributions as soon as possible, as lowering or stopping contributions will reduce the amount your employer pays in Commenting on the figures, Becky O’Connor, Head of Pensions and Savings for interactive investor, said: “During the first lockdown, at a time when some were losing jobs or at least part of their income, the growth in membership of workplace pension schemes slowed and contributions declined.

“These figures show us that unless economic fortunes reverse soon, the impact of the pandemic may not just be felt in the immediate term but also in decades to come, when today’s younger workers retire with potentially less than they need, because they were unable to contribute enough to a pension during their working lives.

“Even without the pandemic, the risk of retiring without enough to last is real for workers in today’s defined contribution schemes if they are only paying in the minimum amount.”

• While providing a short-term cash boost, Aegon analysis shows the damaging long-term impact to retirement income for those considering reducing or stopping pension contributions
• For a 25-year-old employee on average earnings, stopping contributions for 3 years could mean losing out on £15,500 at state pension age
• Similarly, reducing pension contributions by just 1% of earnings until state pension age could mean losing out on £18,400
• If the 1% reduction was matched by a 1% decrease from their employer, this would mean losing out on £36,800 at state pension age

Covid-19 has placed significant financial pressures on many individuals, and some may consider ‘opting out’ of a workplace scheme* or stopping contributions entirely for a period. Others who are paying above the minimum auto-enrolment contribution rate of 5% of a band of earnings may instead consider reducing pension contribution levels to ease what will hopefully be a short-lived burden. While this may offer some financial relief today, Aegon analysis shows even a 1% reduction in personal contribution rate or 3-year ‘pension pause’ could have a significant long-term impact on retirement income.

For 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%, stopping contributions to their pension entirely but starting up again after three years at the previous contribution level, could mean losing out on £15,500** at state pension age (SPA). This assumes, as is highly likely, their employer also stops contributions. Eligible employees who opt out of a workplace pension scheme will be re-enrolled at their employer’s re-enrolment date, up to three years after opting out***.

Rather than ‘pause’ pension contributions for a period, if this individual decides to reduce personal contributions by just 1% until SPA, this could mean losing out on £18,400 at SPA**. The 1% decrease is equivalent to an initial reduction in monthly pension contributions of £14 from take home pay.
Some employers ‘match’ employee contributions which could mean reducing personal contributions by 1% leads to the employer also reducing by 1% which would double the loss in retirement funds to £36,800.

Table 1 - Aegon Analysis, December 2020. Individual is 25 years old with a pension pot of £10k. The decrease in contribution and three-year break is taken from 2020. Starting Salary, £27,000 increases 3% annually. Investment growth, 4.25%

Table 2 - Aegon Analysis, December 2020. The total fund value without a break or reduction in contributions is calculated at £209,600 at state pension age with a total pension contribution of 10%. Individual is 25 years old with a pension pot of £10k. The decrease in contribution and three-year break is taken from 2020. Starting Salary, £27,000 increases 3% annually. Investment growth, 4.25%

Steven Cameron, Pensions Director at Aegon, comments:
“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.”

References:
*GOV.UK, Workplace Pensions. For those enrolled in a workplace scheme, the auto enrolment minimum pension contributions are 5% from employees and 3% from employers - 8% total contribution based on a band of earnings between £6,240 and £50,000 (2020/21). Employees receive tax relief on their personal contributions meaning a ‘basic rate’ income taxpayer will contribute 4% out of their take-home pay. However, many employees and employers pay more than the statutory minimum in the hope of generating a more comfortable income in retirement.
**The figures in Aegon’s analysis assume investments grow at 4.25% after charges and earnings grow at 3% per year. The figures also assume a decrease or stop in pension contributions from 2020. Fund values are in today’s money terms adjusted for 2% inflation. Inputs and assumptions below:

***TPR, Re-enrolment and re-declaration

Further information
Samuel Woods
PR Officer
Aegon UK
sam.woods@aegon.co.uk

Notes:-
• Investment returns in pensions are not guaranteed and the value of any investment can go down as well as up. You could get back less than you invested.
• In the UK, Aegon offers retirement, workplace savings and protection solutions to over three million customers. Aegon employs around 2,000 people in the UK and together with a further 800 people employed by Atos, we serve the needs of our customers. More information: www.aegon.co.uk
• As an international life insurance, pensions and asset management group based in The Hague, Aegon has businesses in over twenty markets in the Americas, Europe and Asia. Aegon companies employ over 26,000 people and have millions of customers across the globe. Further information: www.aegon.com
• Figures correct as of November 2019.