Trouble ahead for today's pension dropouts

Squeezed incomes have cut long-term savings, but that will mean a difficult retirement. Chiara Cavaglieri reports

(OLI SCARFF / GETTY IMAGES)

With rising bills and the threat of unemployment hanging over many British homes, it's easy to see why savers focus on the here and now rather than the never-never.

No wonder, according to insurance giant Prudential, 35 per cent of pension scheme members have frozen their contributions because they are out of work or simply don't have enough money to continue to save. Even more of a concern is that 43 per cent of those who have stopped paying into their pension pots have no plans to start again.

"It's all pointing in the same direction: there is a clear decline in pension engagement at the moment," says Tom McPhail, the head of pensions at independent financial adviser (IFA) Hargreaves Lansdown. "Given that people don't have enough money to sustain their current lifestyles it's hardly surprising."

Prudential's findings come shortly after news that negativity towards pensions is at an all-time high. The annual National Association of Pension Funds (NAPF) survey reveals that 48 per cent of working adults have no confidence in pensions and six in 10 people do not believe their pension will give them enough money to live on in retirement.

With auto-enrolment on its way next year, experts are concerned that people have so little faith in the idea of saving into a pension. Many are looking elsewhere for their retirement planning, with about two million over-fifties saying they will rely on their home to fund their retirement, according to figures from investment firm LV. But with property prices falling, this is an uncertain strategy.

Relying on the state pension seems a risky move too: we are going to have to wait longer to receive it and there is no guarantee that this will be enough to live on. Even if, as pensioners, we can live off the money provided by the state, which is unlikely, those who don't save into a pension fund now miss out on significant tax relief during their working lives. With average pension contributions at 6.2 per cent of income, an individual earning £1m in his or her working lifetime could receive more than £15,000 in pension tax relief, according to Prudential. Add any additional employer contributions and potential gains from stock market fund performance and the benefit of a pension starts to make sense. Halting payments on a company pension scheme is like turning down free money.

"Abandoning your pension pot should be a last resort when times are tough," says Vince Smith-Hughes, Prudential's head of business development. "By getting into the routine of saving into a pension as early as possible, savers will ensure the comfortable retirement that they deserve."

Despite this, it's easy to see why people are fed up. Turmoil in stock markets across the world has seen pension funds fall in value and annuity rates plummet; household budgets are already stretched by rising energy bills and unemployment rose by 80,000 to 2.51 million in the three months to July. So, when savers are opening their pension statement and discovering that despite putting aside their hard-earned cash each month, their pension pot hasn't grown or even may be worth less, the obvious reaction may be to pull out. However, experts say this is short-sighted.

"It's understandable that unemployment or tight household budgets are prompting people to question their pension. But we'd urge them not to quit, even if it means paying in the very minimum to keep the pension going," says Joanne Segars, NAPF's chief executive.

By far the two most important factors that influence how much you have to live on in retirement are how much you pay into your pension fund and how long you make contributions for. The level of charges, investment growth and what you do with that pension pot at retirement will have a considerable impact, but the simple truth is that if you haven't paid in enough money and for long enough, there is little that can be done. Attempting to make up for lost years will mean paying much more into the pension or working for much longer.

If in tough times you are struggling to find money, it is far better to reduce your payments rather than stop them altogether. If you were to suspend your pension contributions for three years, this would typically reduce the eventual payout by about 10 per cent, says Mr McPhail. For a 35-year-old saving £1,200 a year to age 65, with 6 per cent investment growth after charges, this would equate to a fund value falling from £66,796 to £59,844.

"Once you've completely opted out there is a risk you might not opt back in again," says Mr McPhail. "I would urge them to look at curbing other areas of their expenditure first because they are not solving a problem, they are simply deferring it."

Expert View

Tom McPhail, Hargreaves Lansdown

"In the context of pay freezes and unemployment, the first thing to go is often long-term savings, but that doesn't solve the problem. It just kicks the can further down the road. You're still going to have to deal with the problem later and you'll either have less to live on at retirement or you must keep on working for longer."