This short-term saving could leave people open to a tough retirement

Chiara Cavaglieri and Julian Knight discover the dangers of reducing or even stopping your pension payments
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The Independent Online

The country may be coming out of recession quicker than expected, but times are still tough for millions of Britons loaded with debt.

No surprise, therefore, that economising has been the watchword for many people, but you can go too far. Pension savers, for instance, are being warned against suspending their monthly contributions. Many people are now choosing to reduce or hold off altogether from paying into their retirement funds, but experts warn that that they risk facing significant financial hardship later down the line.

The recently published Scottish Widows UK pensions report, which tracks the percentage of people saving adequately for their retirement, fell to 48 per cent – its lowest level since 2006. Of those surveyed, 18 per cent say the recession has pushed retirement lower on their list of priorities, prompting them potentially to cut back on contributions or to stop paying into a pension altogether.

"It's understandable that the tough jobs market and uncertain economy have left people feeling pressured, but they should think very hard before cutting their pension. People simply aren't saving enough for their retirement, and it's a serious issue for our society. Short-term savings made now will only fuel a longer-term problem, says Joanne Segars, chief executive of the National Association of Pension Funds (NAPF).

A big issue here is the value that savers place on pension schemes. With many people entering retirement hit by stock market drops and falling annuity rates, it's understandable that anyone starting a pension now feels a little jaded. The prospect of having to scrimp and save now and not being able to touch that money until 65, or even later, is already a turn-off for many. But when budgets are stretched it's easy to see why people want to cut back on their pension funding.

"When money becomes tight and people are trying to cut their expenditure, it is savings such as pensions which often come under attack first," says Danny Cox from independent financial adviser (IFA) Hargreaves Lansdown. "It's easy to see why. Pensions are perceived as something paid into now with no immediate benefit. Retirement feels a long way off so you have plenty of time to catch up later."

Despite the temptation, whether you have a personal or company "defined contribution" fund, the long-term effect of withholding pension payments can be stark. For someone starting their pension at age 35 and paying £100 a month, increasing at 2.5 per cent a year with 6 per cent investment growth, if you were to miss a year's worth of contributions from year 10 and were planning to retire at age 65, your fund value would drop from £179,351 to £172,919, a 3.59 per cent drop. Miss out five years' worth of payments and your fund would fade to just £149,246, more than £30,000 off the original retirement target.

For the majority of people it is vital to have an income in retirement, and those with only the state pension to fall back on are playing a risky game. Of all the savings vehicles, pensions are still the most tax efficient. When you pay into a pension, tax relief means a basic rate taxpayer making a £100 contribution will cost you £80. Higher rate taxpayers benefit even more with a £100 contribution costing just £60. If you have an employer matching your contributions, you're sitting pretty with a further top-up to your contributions. Taking a break from this type of scheme can have an even bigger impact on your projected fund. Every pound is effectively doubled by the employer, so what may seem like a short-term fix now could be a serious regret later.

Even without the potential loss to your retirement fund, the practicalities of curbing or stopping payments may restrict your options. If you're in a group personal pension or defined contribution scheme you may also be able to take a contribution holiday or reduce payments, but you will need to speak to your pension administrator to see what flexibility you have. If your employer is making a contribution, there is a chance that as one of the conditions you must always make contributions.

For anyone lucky enough to be in a final salary pension, there is far less flexibility and you simply may not have the option to reduce payments. Even if you can, experts advise not to.

"The benefits associated with a final salary scheme are simply too great. There may be death in service included in the scheme and you may not have the option to rejoin, especially if the company has closed the final salary scheme," says Lorreine Kennedy from IFA CareMatters.

Final salary pensions are by far the most lucrative type of scheme and the numbers now open are shrinking. Only 11 per cent of private sector workers currently belong to a final salary pension, compared with 94 per cent in the public sector. But in the public sector the squeeze is on, so the percentage is bound to fall over time.

If you have a personal pension plan it will be more straightforward to stop, increase or decrease your contributions. All it will require is a written request to your pension provider. But some older pensions may apply penalties and there is a chance you'll miss out on guarantees or guaranteed annuity rates if you stop payments.

If you do decide to miss payments, another important issue, particularly if you have a personal pension plan or Sipp, is that it can be difficult to motivate yourself into restarting payments when your financial situation changes. Just like going to the dentist, it's all too easy to put off starting those payments and you may find that your potential pension pot is quickly eroded. With these dangers in mind, experts advise looking for other ways to cut back first, including reviewing all your other financial products. For those that can, having an emergency fund such as an ISA which can be easily accessed to fall back can protect against being forced into reducing pension payments.

Above all, be realistic about how much you need to fund your desired retirement and to understand where you stand based on your current plans, as well as the implications of failing to save enough now.

"The sad fact is that many people seem content to bury their heads in the sand regarding their retirement income. People in their twenties and thirties seem to think it's not something they need to worry about yet, while people in their fifties begin to realise they should have saved earlier," says Nick Evans from IFA One Life.

Expert View

Danny Cox, Hargreaves Lansdown

"The problem is already people aren't paying enough into their pensions, and by stopping savings, even for a few months, it sets them back even further.

When considering cutting back, pensions have to be seen as being a high priority; otherwise retirement will be even more austere."

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