Updated 03 September 2020
The coronavirus lockdown is forcing millions of us to reduce our spending and economise. But one thing you shouldn’t cut back on, if possible, is contributing to your workplace pension. Here’s why. Article by Nick Green.
When minimum workplace pension contributions were raised to 5 per cent (for employees) last year, some commentators raised concerns that this would hurt the take-home incomes of workers at a time of economic uncertainty. Looking back from the middle of the COVID-19 crisis, that ‘uncertain time’ looks like a golden age. With millions now furloughed from work and facing a 20 per cent loss of income, many will be tempted to pause workplace pension contributions to save money, or even opt out of their scheme altogether.
However, it’s a temptation that should be resisted for as long as possible. Although paying into a workplace pension may at the time feel like an expense, it’s actually a huge net benefit. For every four pounds paid into a pension, the government adds another pound through tax relief (essentially a 25 per cent boost to your money). On top of this, your employer must make contributions equivalent to at least 3 per cent of your wages, and if you choose to pay more than your minimum 5 per cent then many employers will increase their contributions too. Some employer contributions can be extremely generous, amounting to 10 per cent or more of salary.
‘You’d essentially be turning down free money [by opting out],’ says Tom Selby, a senior analyst at stockbroker AJ Bell. He argues that the current uncertainty is all the more reason to hold on to one’s workplace pension. ‘Once you have made that contribution, the money is yours – albeit you won’t be able to access it until your mid-50s. So even if you lose your job, your [workplace] pension will remain your property.’
The coronavirus pandemic is a reminder of how the unexpected can and does happen, and of the huge potential impact. Incidents like this are often referred to as ‘Black Swan’ events; damaging occurrences that beforehand seemed highly unlikely, yet which in hindsight appear predictable. The 2008 financial crisis was another recent example of a Black Swan, and there are likely to be many more over the coming decades.
The frequency of Black Swan events is such that a person retiring today could expect to see at least one more over their course of their retirement, and perhaps as many as three. By definition such events are never expected, so the only way to prepare for them is to put adequate safety nets in place to cushion the financial impact. In the case of a retired person, this means having pension arrangements that are as robust as possible.
This means that suspending or halting workplace pension contributions now is false economy. Not only is it turning down a large sum of free money from one’s employer and the government, but it is also effectively ‘robbing’ your older self of a substantial amount, merely in order to have slightly more income now. Since you don’t know what circumstances you may face in the future, or what other crises may strike between now and then, it’s best to consider your pension contributions as ring-fenced, and aim to make whatever savings you can in other areas of your life.
The government’s Coronavirus Job Retention Scheme (also called the furlough scheme) provides 80 per cent of employees’ income up to a maximum £2,500 per month, and also covers employer workplace pension contributions at the statutory minimum of 3 per cent. Note that this will be 3 per cent of your furloughed income, not your usual income, so your pension contributions will fall during the furlough period. Your own (employee) contributions will shrink too, since these are a percentage of your pay. However, if you are in a position to increase these to compensate, then your workplace pension scheme may allow you to do this.
Remember that if you pause your workplace pension contributions, you will also lose out on your employer contributions. So although a reduction in your pension saving may be unavoidable at this time, you should still retain as much as you can, because it is an invaluable protection against future events like this one.
One good use of your time during the lockdown period may be to assess your workplace pension and see if it is working hard enough for you. Here are some tips for improving it:
Your most recent pension statement should include a projection of the level of income you can expect from this scheme in retirement, assuming a similar level of pension saving for the rest of your working life. Add this figure to your expected state pension (bearing in mind the rising state pension age) and see if looks adequate for your future needs. If it doesn’t, then you can make a resolution to increase your employee contributions soon after your work returns to normal. If your employer matches or doubles your increased contributions, this makes it even more worthwhile.
Many people aren’t aware that they have a choice of workplace pension funds. Unless you state otherwise, your pension contributions will be invested in the scheme’s default fund. This fund will have been set up broadly to suit everyone, from young recruits to those approaching retirement. Consequently, it may not be ideal for anyone, and you yourself may benefit from choosing a different fund more tailored to your life stage. Research has shown that fund selection can have a huge difference on someone’s final level of pension savings, so talk to your financial adviser about whether an alternative fund would suit you.
Now may also be an ideal opportunity to trace your old pensions from previous jobs. There may be pension pots that you have forgotten about or never knew existed – this is particularly common with pensions from a first job, when retirement is the last thing on your mind. Use the Pension Tracing Service to track them down, and ask a financial adviser about whether you should combine them into one (this is usually the best decision, but not always). At the very least, make sure that the schemes have your correct contact details, and that your Expression of Wish forms are up to date.
If you’re within 15 years of your planned retirement age, start thinking about how you will take your pension. This is very useful, as your future plans will influence your choice of funds over the final decade of pension saving. For example, if you are planning to buy an annuity (a guaranteed income for life) then you will want to start moving into lower-risk assets a few years ahead of time. If you are planning on keeping your pot invested, your strategy may be different. Your financial adviser can explain your options in detail.
Pension statements from your scheme can only tell you so much, and won’t give you the full picture of your financial situation (since they only cover each pot in isolation). The best way to get a clear picture of your pension situation is to consult an independent financial adviser. Many advisers found through Unbiased.co.uk offer free pension checks, which assess your current situation impartially without making specific recommendations. This is a great way to get started on the process of improving your workplace pension arrangements.
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