What is the impact of opting out of my pension?

With the cost of living still putting the squeeze on finances, it’s only natural that a lot of people are looking for ways to cut costs. For some, opting out of their workplace pension contributions might be an appealing way to claw back a bit of extra cash each month. But while it’s true that putting your pension on pause can increase the amount of money you take home in the short-term, it could also have a surprisingly large impact upon your retirement plans.

Short-term gain

Of course, the short-term benefits or stopping you pension contribution, even temporarily, are immediately obvious. If you contribute £75 a month into your pension pot, that’s £75 that going into you take-home pay each month instead. For some, that won’t make a big difference to their finances, but if you’re currently struggling with the increased cost of bills and shopping, an extra £75 could make the difference between finishing the month in the red and finishing in the black.

While pausing your pension contributions might seem like an easy way to have a bit more cash each month, the long-term impact this can have on your pension and retirement plans can be surprising.

Long-term shortfall

As an example, if you normally contribute £100 a month into your pension pot and stop those contributions for a year, you could find yourself with £6,300 less in pension savings when it’s time to retire. If you stop paying for two years, your pension pot could be £12,500 short and if you skip three whole years, this could increase to around £18,600*. Those may seem like surprisingly big numbers - so how is this possible?

Well, as well as the money you pay into your pension pot each month, a number of additional factors help to boost the amount you save.

Your employer contributions

Firstly, if you pay into your workplace pension every month, your employer also pays in. The amount an employer contributes can vary but they are required to match at least 3% of your salary, assuming you are paying in too. So, if you normally contribute £100 a month into your pension pot, and this is 5% of your salary, your employer would also contribute a minimum of a further £60, for a total of £160. Depending on your employer, they may even contribute more – so you can already see how your money could go further by going into your pension.

Government tax relief

Another benefit of paying into your pension is something called tax relief, which essentially means any money you pay into your pension is worth ‘more’ than it would be in your bank account. That’s because you don’t pay income tax on your pension contributions, so some of the tax you would have paid goes into your pension saving instead. If you pay income tax at the basic rate of 20%, for every £100 that you pay into your pension pot, £20 of this is covered by the government - meaning the net cost to you is actually only £80.

The power of compound returns

As you pay into your pension pot, this money doesn’t just sit there but is instead invested to help it grow. Over time, compounding your returns by simply leaving them invested could help you ride through any market volatility. In time this means you could realise total returns that could be much more that the total initial amount you invested. This is called ‘compound returns’ and means that a combination of time and continued investment can have a big impact on your savings over time. Pausing your pension contributions doesn’t stop you from earning returns on what you have already invested – but without contributing, it does slow down the process.

The trade-off: a little now or a lot later

As you can see, a little can go a long way when it comes investing in your pension. A combination of employer contributions, government tax relief and compound returns means that you could get a lot more out of your money in the long-term by contributing to your pension than by stopping your contributions. Of course, everyone’s situation is different and it may be that a bit of extra money now is absolutely essential to get by. In this case, the short-term gains made by pausing your contributions could be the right choice for you. However we hope this illustrates how much difference continuing your pension contributions can make to your pension savings, and how positive an impact this could have on your retirement plans.

*These figures are based on a 30-year-old with a salary of £24,000. They assume that the salary and pension contributions increase by 3% each year, and that investment growth from the pension savings is 5% a year. They also assume a retirement age of 65.